MIDLAND, Texas—As IPO fever seems to be cooling off, the Permian Basin is well positioned to rekindle the market. The slump in crude oil prices has definitely put IPOs on ice for the time being, said Mike Kelly, managing director and head of E&P research, Global Hunter Securities LLC.

Kelly said investors still favor the Permian relative to just about every other basin.

“Wall Street wants to come back to the Permian,” he said at Hart Energy’s Executive Oil Conference earlier this month. “If we get oil prices settled here, there are buyers in our opinion.”

In recent years, pure Permian players such as Diamondback Energy Inc. (NASDAQ: FANG), Athlon Energy Inc. (NYSE: ATHL), RSP Permian Inc. (NYSE: RSPP) and Parsley Energy Inc. (NYSE: PE), have had an extraordinary response from public markets.

“The IPOs that have come out of here really have not poisoned the well,” Kelly said. “You’ve got just phenomenal performance in terms of metrics, production growth, return on capital. It’s all there from these Permian IPOs.”

Game Changer

A turning point for the basin came around 2012 with the discovery of the horizontal Wolfcamp Shale play in the southern end of the Midland Basin. As the Wolfcamp developed, the region’s players were forced to rethink their strategy. Steve Gray, CEO and director of RSP Permian, was one of them.

RSP Permian, which was originally backed by Natural Gas Partners, first formed in 2010 with 16,000 acres in the Midland Basin. Gray, who also spoke at the conference, said the plan was the typical buy, build and sell strategy.

The Midland, Texas-based company started out drilling vertical Wolfberry wells, but eventually shifted to horizontal drilling. As a consequence of the switch, the company’s production grew 10-fold to 15,000 barrels per day (bbl/d) from 1,500 bbl/d, he said.

“This horizontal boom created a huge opportunity for us, but here was the issue: Just as we were thinking it might be time to monetize the assets and sell them, it became clear to us that the reserve base under these leases was a lot larger than we realized,” he said.

Gray said the company was forced to make a pivotal decision in 2013. The company could either sell the company as it originally had planned or continue to develop its assets themselves, which meant finding more capital.

“We were looking at a possible $10 billion capital spend over 15 years to develop these assets,” he said. “That type of money even outstripped the private equity model that we had used in the past.”

At that time, several of RSP’s peers were choosing the public market route. Gray said he watched as Diamondback and others were traded at a premium compared to companies in other basins.

The Permian was one of the more highly valued basins at the time, he said.

“At the end of the day we made the decision and we decided to go public because we felt like it was the right thing to do for our shareholders and because it was the best way to unlock the value,” he said.

Since RSP's $390 million IPO closed in January 2014, the company's stock performance has been exceptional, Kelly said. The company’s annualized stock return has grown by about 30%, as of Nov. 7.

Permian Upside

Permian pure players, such as RSP, are among the top in all categories of Global Hunter’s five pillars of investing, which include returns, growth, inventory, balance sheet and valuation, Kelly said.

“These Permian pure plays are definitely five-tool players,” he said. “They’re all-stars relative to the rest of the E&P universe.”

For example, Permian players are stock full of drilling opportunities. Companies have an inventory of 25 years on average due to the stacked pay nature of the play, he said.

The allure of the basin is leading several public players to shed noncore assets and become more Permian pure play, he said.

So far this year, Energen Co. (NYSE: EGN) sold off its utilities segment and put its dry gas assets on the market in San Juan to get more Permian leverage. Laredo Petroleum Inc. sold its Midcontinent assets to EnerVest Ltd. last year.

Pioneer Natural Resources Co. (NYSE: PXD) has made several divestitures recently in the Barnett, Hugoton, Alaska and may ultimately exit the Eagle Ford because they want to put on more Permian weight, he said.

Kelly said acreage prices in the Permian can be justified at much higher levels than where they are today due to two key factors—stacked pay potential and enhanced completions.

“We think that as Wall Street gets more comfortable with this and producers really prove that there’s no cannibalization between zones, and you’ve got a zone that really is a separate reservoir relative to what’s below and above it, Wall Street will give more credit in terms of a per acre basis,” he said.