RSP Permian Wins An Expensive Prize In The Delaware Basin

| About: RSP Permian (RSPP)

Summary

RSP Permian is paying ~$50,000 per undeveloped acre to acquire a high-quality block in the Delaware Basin.

The premium price is in large part explained by the relatively low average royalty burden.

The transaction is effectively a “stock-for-stock exchange” for RSPP’s existing shareholders and does not represents an intrinsic value dilution on a per-share basis.

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Important note: This article is not an investment recommendation and should not to be relied upon when making investment decisions - investors should conduct their own comprehensive research. Please read the disclaimer at the end of this article.

RSP Permian (NYSE:RSPP) emerged as the winner in the anticipated Silver Hill sale, paying $2.544 billion (based on the stock's pre-announcement closing price) for 41,000 net acres and associated production in the Delaware Basin. As a reminder, a report by The Wall Street Journal ten days ago suggested that the transaction was imminent and Diamondback Energy (NASDAQ:FANG), a rival operator in the Permian, was likely to be the high bidder, with a price of $2.5 billion. The sellers are affiliates of Kayne Anderson and Ridgemont Equity Partners, private equity firms, and other private investors.

Based on the disclosure in the press release, the transaction appears to imply a valuation of ~$50,000-$52,000 per undeveloped acre, which is, arguably, a new record for the Delaware Basin. The relatively low royalty burden - ~17% for the operated acreage - is one of the factors explaining, at least in part, the rich valuation.

While the price being paid is quite high, the equity funding effectively makes this acquisition a "stock-for-stock exchange" and eliminates most of the downside risk for RSP Permian's existing shareholders. By the same token, the upside from the transaction appears moderate, unless one assumes that the quality of the acquired acreage is materially better than what RSP Permian already has in its portfolio.

Overall, the development is a modest positive for RSP Permian's stock, in my opinion. The acquired acreage is blocked up and located mostly in the Delaware Basin's "Core." Given the stock's rich trading multiples prior to the acquisition, implying a similarly high valuation per undeveloped acre in the existing portfolio, the transaction does not lead to a noticeable dilution in terms of intrinsic value per share. This is essentially a "scaling-up" transaction, in large part bankrolled by the new investors in the stock.

The acquisition provides additional operational optionality for RSP Permian. The broader pro forma footprint should offer a greater opportunity set for capital allocation, whereas larger market capitalization should appeal to institutional investors.

Overall, the stock's trading multiple remain quite high and appear to reflect an expectation of a meaningful recovery in oil prices from the current levels.

Transaction Metrics

RSP Permian is acquiring a total of 41,000 net acres in northeast Loving and northwest Winkler Counties, Texas, of which over 80% are operated. Current production from the properties is ~15,000 Boe/d (69% oil, 86% liquids) from net 49 horizontal and 9 vertical wells.

In its press release, RSP Permian commented that acreage is located "in the thickest, deepest part of the Delaware Basin, which is significantly over-pressured." The company sees 7 horizontal pay zones under the acreage, including the Wolfcamp B, upper and lower Wolfcamp A, 3rd Bone Spring, 2nd Bone Spring, Avalon, and Brushy Canyon, with ~1,950 net total undeveloped locations with average lateral length of ~6,300 feet.

Offset operators include EOG Resources (NYSE:EOG), Anadarko Petroleum (NYSE:APC), Royal Dutch Shell (NYSE:RDS.A), Matador Resources (NYSE:MTDR) and Devon Energy (NYSE:DVN).

At the time of this writing, the company has not provided any reserve or PV-10 metrics for the acquired properties. Based on the limited information, I estimate the M&A value of the existing production at ~$400-$500 million, which implies a valuation of ~$50,000-$52,000 per undeveloped acre.

A Stock-Funded Acquisition

The announcement confirms the equity-funded scenario that I predicted in my earlier note as the solely feasible transaction structure:

Goes without saying, an acquisition of this size will require equity. The most logical financing solution would be a combination of a public equity and/or convertible offering and equity issued to the seller. Ideally, the acquirer - which I assume to be Diamondback, based on the report by The WSJ - would need to raise close to $3 billion in equity and/or equity-linked financing to secure funds for accelerated development of the properties, including infrastructure, and potential bolt-on acquisitions and leasing.

RSP Permian is paying $1.25 billion of cash and 31.0 million shares of RSPP common stock to the seller. Immediately following the announcement, the company priced an underwritten public equity offering of 25.3 million shares (assuming full green shoe) at $39.75 per share. Total gross proceeds to the company will be approximately $1.0 billion. In other words, RSP Permian will be funding just ~$250 million of the consideration from cash on hand and via borrowing, with the balance being paid by issuing new shares.

Upon closing, Kayne Anderson, Ridgemont and other Silver Hill shareholders will own ~20% of RSP Permian's outstanding shares. Kyle Miller, CEO of Silver Hill, is expected to join RSP's Board.

The company's pro forma current production would be approximately 50 MBoe/d.

In Conclusion…

The acquisition extends the list of recent acreage divestitures in the Permian Basin by private equity firms to publicly traded operators whose stocks are trading at premium multiples.

The high per-acre valuation in the transaction is in part explained by the relatively low royalty burden and significant equity component (approximately half) in the consideration.

The development is a modest positive for RSPP stock, even though the equity offering may initially put pressure on the stock price.

The company needs to issue additional equity to accelerate the development of the properties and pursue additional bolt-on acquisition and leasing opportunities.

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