Diamondback buys QEP, Guidon to bulk up in Midland Basin

Houston — Diamondback Energy moved Dec 21 to buy small Texas Permian Basin operators QEP Resources and Guidon Energy, for a total of nearly $3 billion, continuing a streak of large corporate takeovers in the US' biggest oil basin in the quest for scale and greater cash flows.

The pair of "disciplined" acquisitions, which expand Diamondback's Midland Basin footprint in the eastern Permian at a time when operators are batting down costs and building efficiencies amid volatile low oil prices, contribute largely overlapping assets to Diamondback, company CEO Travis Stice said on a conference call.

"These acquisitions check every box," Stice said. "They are both accretive, both together and individually on all relevant 2021 metrics – free cash flow per share, cash flow per share and leverage even before accounting for synergies."

"And, this accretion only increases over time as the pro forma high-graded development plan results in more cash flow and therefore the return on capital per share," he said.

QEP, a public company, comes with 49,000 net acres and 77,000 boe/d, of which 48,000 boe/d is in the Midland Basin and the rest in the Williston Basin.

Pre-acquisitions, Diamondback has 347,000 net Midland and Delaware basin acres, excluding exploration and conventional acreage. Its Q3 2020 production was 287,000 boe/d, nearly 60% oil weighted.

Will divest or harvest cash from Williston

Diamondback intends to "opportunistically" divest the Williston assets or harvest them for cash flow, said Stice.

Privately held Guidon comes with about 32,500 net acres and 18,000 boe/d of production, built in part on consolidation of smaller operators.

The QEP transaction is anticipated to close in late Q1 or Q2 while Guidon should close in Q2. Upon closing, Diamondback intends to reduce funding from existing assets to high-grade development and accelerate activity on the new assets, Stice said.

The deals are largely paid for with Diamondback shares. QEP, the larger of the two acquisitions at $2.1 billion, all of it stock, had widely been talked up by industry as a takeover target for its small size, solid core assets and cash flow potential, analysts said.

"Acquisition of QEP by Diamondback fits firmly within the mold established for 2020 public E&P consolidation," Enverus analyst Andrew Dittmar said. "The deal is structured with no premium and all-stock consideration. It focuses on immediately boosting cash flow to fund shareholder capital returns and debt reduction."

QEP was in a "tough" place in the upstream since it lacked scale to compete, he said. Having the company under its wing allows Diamondback to capture more cash flows through anticipated synergies of $60 million to $80 million per year.

QEP's core Northern Midland acreage is supported by a "significant" midstream asset base, which likely creates additional dropdown opportunities for Diamondback to its own midstream affiliate Rattler, Dittmar said.

In addition, Diamondback will pay $862 million for little-known Guidon, a company formed in 2016 backed with private equity funds from Blackstone. Of the total consideration, $375 million will be paid in cash and the rest shares.

That buyout resembles acquisitions of private equity-backed companies in prior years, with a mix of cash and stock. But "asset valuations have been reworked with a higher percentage of the total value targeting PDP [proved developed reserves] and less paid for undeveloped land in a lower rig rate environment," said Dittmar.

Sufficient scale

While Diamondback's acquisition appetite in moving to scoop up QEP and Guidon "somewhat conflicts" with its recent comment of having "sufficient scale to compete plus," the company's current announcements align with its acquisitive track record, investment bank Tudor Pickering Holt said.

Moreover, "the no-premium transactions add relatively top-tier exposure to Diamondback's legacy asset base...and ideally closes the book on M&A in the near term" for Diamondback, TPH said in a Dec. 21 investor note.

Diamondback had been a consolidator even prior to the current announcements. In late 2018 it closed a hefty $9 billion purchase of large Permian producer Energen Corp. that gave it assets in not only the Midland Basin but the Delaware Basin – the western Permian.

While many of the biggest Permian midsized to small Permian operators have already been taken out, remaining private equity-backed E&Ps in the basin are "on the table as potential targets," said Dittmar, but did not immediately specify names.

"Many of these companies were built with plans for an eventually exit via sale to a public E&P – plans that have been challenged by the current market" of oil prices below $50/b, he said. "To get a deal across the finish line, would-be sellers may have to temper expectations on the ratio of cash received versus equity, and the overall valuation on their assets. In these situations, finding a buyer like Diamondback whose equity the sponsor is comfortable holding is likely critical."