Diamondback Energy - Investors Are Skeptical About Valuation Which Is Based On Growth

| About: Diamondback Energy (FANG)

Diamondback Energy (NASDAQ:FANG) made its public debut on Friday. Shares of the independent oil and natural gas company ended their first day unchanged at $17.50 per share.

The Public Offering

Diamondback Energy is an oil and natural gas company focused on the acquisition, development, exploration and exploitation of onshore oil and natural gas reserves in the Permian Basin in Texas. The company was founded in 2007, holding interests in 182 producing wells in the Permian Basin.

The company sold 12.5 million shares for $17.50 a piece. Diamondback Energy raised $219 million in gross proceeds in the offering process. Based on the offer price of $17.50, the firm is valued at $614 million.

The offering was quite a disappointment. The offer price was set at the lower end of the preliminary $17.00-$19.00 price range set by the firm and its bankers.

The firm sold all of the shares, with no shares being offered by selling shareholders. In total, 36% of the company's shares outstanding were offered. At Friday's closing price of $17.50 per share, the firm is valued at $614 million.

Diamondback energy was brought public by Credit Suisse.


Diamondback energy operates in the long term growth industry of unconventional onshore oil and natural gas reserves in the US. The company has reserves in over 329 wells, totaling 39,460 MBOE. Roughly two-thirds of the reserves are oil, with the remainder in natural gas. The Permian base is 49,703 acreage large, in which the average working interest is 86.2%. In total there is the potential of 977 drilling locations.

For the full year of 2011, Diamondback Energy generated revenues of $48.7 million, up 74.2% on the year before. The company reported a loss of $0.5 million, as a result of a $13.0 million loss on derivative contracts. In 2010, the company reported a net profit of $8.2 million.

Total proven reserves come in at 9.4 million barrels of oil-equivalent. The company has unproven reserves of 30.0 million, for a total of 39.4 million estimated proven and unproven reserves.

Diamondback energy intends to use the $219 million in gross proceeds to repay outstanding borrowings under its credit facility. Furthermore $63.6 million will be used to repay the Gulfport contribution note, and the remainder will be used for general corporate purposes.

Excluding the offering, the company operates with $6.8 million in cash and equivalents and has $91.1 million in notes payable and derivatives outstanding, as of 2011. As such, Diamondback energy operates with a net debt position of roughly $85 million. Including the gross proceeds of the offering, the net cash position will be roughly $120 million. This values the firm's operating assets around $500 million.

Based on 2011s annual revenues of $48.7 million, this values the operating assets at roughly 10 times annual revenues. The company net lost money in 2011. Excluding the loss on derivatives contracts, the company would have turned a $12.5 million profit. This values the firm at 40 times operating assets.

Investment Thesis

The offering of Diamondback energy was a little disappointing. Shares ended the day unchanged after trading with gains of up to 4% during the first trading day. Trades are now trading some 3% below the midpoint of the initially guided price range of $17-$19 per share.

The company intends to retain funds for the expansion of the business and it does not anticipate declaring cash dividends in the foreseeable future.

With many offering scheduled over the past week, there was little attention for Diamondback. In Friday's trading session, a lot of investors were focused on the very successful offering of Workday (WDAY), which shares closed 74% higher on the day.

Investors in Diamondback energy are not too enthusiastic about the offering. Operational performance of the company has been good with revenues growing year-on-year. The company did report a minor loss in 2011 on the back of derivative losses. The company engages in swap derivatives in order to smoothen out cash flows. As such it receives fixed payments for production, while paying floating prices to its counterparties including Hess Corporation and BNP Paribas.

Based on the valuation of $500 million for the operating assets, the market values Diamondback at $53 per barrel of proven reserves. Total reserves, including non-proven reserves, are valued at $13 per barrel. These valuation are not very cheap, based on industry standards. As such a lot of the valuation depends on the realization of more future wells in the Permian base, which will boost proven and unproven reserves.

Investors are not too enthusiastic about the public offering. Private investors have little interest to acquire shares in this company, which valuation heavily depends on future growth and a boost in reserves. The company is showing rapid growth, but is valued at 10 times annual revenues and 40 times normalized profits. I stay on the sidelines, as I find it hard to make an accurate estimate of future growth and discoveries.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.