RSP Permian Inc. announced its acquisition of Silver Hill Energy Partners I and II last October in a two-step deal, the second closing occurring in March 2017.

The deal gives RSP, already one of the technical leaders in the Midland Basin, an equally robust position in the Delaware with comparable—if not better—EURs and financial metrics, according to RSP CEO Steve Gray. The deal included 250,000 net effective horizontal acres across seven horizontal pay zones, with significant operational control; over 80% of the acreage is operated. The deal is being financed with $1.25 billion cash and 31 million RSP shares to Silver Hill.

For the savvy maneuvers and decisions behind this transaction, RSP and Silver Hill receive this year’s Oil and Gas Investor Excellence Award for Best M&A Deal.

The deal had to be negotiated with a bit of subterfuge because both companies are based near each other in Dallas. The two CEOs were at one point planning to meet at a restaurant to talk turkey over lunch and sign the PSA, until one of the principals who’d arrived first called to say a couple of hedge fund people were eating there. No need to tip off the market, so the meeting was quickly rearranged at Steve Gray’s office at RSP.

The assets are in Loving and Winkler counties near the New Mexico border, north of many of the other recently announced deals in the Delaware. In addition, the deal stands out because RSP paid roughly $45,000 per acre, based on the implied price of $2.4 billion, adjusted for flowing production of 15,300 barrels of oil equivalent per day (boe/d) from 58 wells (49 horizontal).

The price set a high water mark when it was announced last October, at the time a higher number than many other buyers had paid to gain entry into the basin. However, these acres are in the thickest part of the Delaware where successful wells have already been drilled in seven different zones. Production here has a higher oil cut than other parts of the basin, and what’s more, RSP now enjoys a runway that is long, with 1,950 net undeveloped locations in the basin. “This was one of the few deals that was accretive from day one,” Gray said. The assets are highly economic at $50 per barrel (bbl) of oil, he added.

The company wanted a position in the Delaware so its geologists had been studying the basin for a while, and RSP even made a run at a couple of other companies, he said. Meanwhile, Silver Hill was evaluating whether to go public or sell when the Delaware area was heating up last fall. CEO Kyle D. Miller called Gray, who said he’d take a look at it—the two have known each other for years.

“After our technical team looked at it, they told me they were jazzed,” Gray said. “But I was very skeptical at first and told them, ‘You’re going to have to convince me, because this was going to be a big ’ole bet for a company our size.’” Besides, RSP was evaluating a different big deal at the same time.

After the team convinced him of Silver Hill’s potential, Gray told the group, “OK, this one is worth stretching for.”

He said the key to this deal coming together was to engage with a seller willing to take some RSP stock. “They’ve got to feel good about that, so part of the negotiation was educating them on the quality of our existing assets as well. Silver Hill was the first deal where we all agreed that a combination of the companies made sense. Luckily we’ve known those guys for a long time. That was definitely a plus.”

“RSP was fine being a smaller company in the Midland Basin, and we would not want to dilute our asset quality,” said CFO Scott McNeill, “so we were willing to be patient. Then when the Silver Hill opportunity presented itself, with higher productivity wells involved, that’s when we leaned in really hard on it.”

From the other side of the table, this transaction marked a spectacular exit for private equity-backed Silver Hill and its main investors, Kayne Anderson Capital Advisors LP and Ridgemont Equity Partners.

Under CEO Miller, the E&P company had been for sale in the summer of 2015 with Jefferies as lead banker. Then commodity prices dropped 30% in July so it pulled back.

Silver Hill decided to keep beefing up its assets, and luckily, the new sale timing turned out to be sweet: it restarted the sales process in May 2016, selling into the white-hot Delaware marketplace in late 2016.
“We had 27,000 acres and basically a horizontal Wolfcamp well and a half at the time, but we told the market we’d pick up a second rig—because we had conviction around the rock,” Miller said. “From September 2015 forward, we maintained two, and then three, rigs. In January 2016 we also bought another 14,000 acres and 2,500 boe/d from Concho Resources in Silver Hill II.

“We could see more positive results coming out of the Delaware and we wanted to be prepared. We originally called our area ‘the hole in the doughnut’ because we had horizontal activity all around us.”

In the early 2000s, Anadarko Petroleum Corp. and Chesapeake Energy Corp. drilled deep vertical wells in the Haley gas field that pretty much held every section, so it was a challenge for new entrants to establish a position there, “but we were fortunate to participate in a series of transactions that allowed us to build scale,” Miller said.

“Starting in about 2014, the industry started to fill in the hole of the doughnut with compelling horizontal results up and down the stratigraphic column. Our technical team did such a tremendous job observing what other operators were doing, and then they used those learnings … to raise the bar for the area.”

For everyone, the real breakthroughs were using more pounds of proppant and slickwater frack designs.

Silver Hill continued to develop two benches in the Wolfcamp and started to delineate the Avalon, Bone Spring and Wolfcamp B. Miller and team managed risked capital by speeding up development of derisked intervals and delineating additional intervals.

“Rules of thumb get broken every day as more operators work the Delaware and expand their acreage,” he said. “Despite the pullback in commodity prices, the industry started to see that you have a very resilient single-well return in the Delaware. We saw our costs decrease by almost 40%, and some of our EURs more than doubled from our early estimates.”

In 2016 Silver Hill began a dual track process to go public or sell; it never filed the S-1 but came within a week of doing so. The Jefferies team again led the M&A process. At the same time, Silver Hill increased its acreage position and delineated multiple intervals. “Plus, in our minds, there was something about having 10,000 bbl/d-plus of production, a nice round number, although a certain scale does attract a certain kind of buyer,” Miller said.

When he wrote the original Silver Hill business plan on a white board, Miller said the goal was to build large enough scale to attract either a large incumbent company nearby or a company needing to enter the Delaware. He found his suitor in RSP.

Picky eaters

One of RSP’s bankers described the RSP executives as picky eaters because they were so careful about when to buy something, when to finance it and when to announce it publicly. RSP was one of the few big E&Ps that did not go to the equity market in 2016 to reload, although various bankers had tried to pitch an offering. McNeill said he didn’t think $30 oil would be around forever, and he had the cushion of a good undrawn bank facility as well. He thinks the fact he didn’t dilute shareholders in 2016 at the low point in the market made a difference when RSP approached them last fall to get on board the $1 billion stock offering.

The original offer was for less cash and more RSP stock, but Silver Hill came back asking for a greater percentage of cash. RSP’s bankers, led by Barclays, said they could do it.

According to CFO McNeill, the market conditions had to be just so because RSP was doing a $1 billion financing overnight. He called 15 or 20 of RSP’s largest shareholders, had them sign a confidentiality agreement and then disclosed details of the proposed transaction. These included heavy hitters such as Goldman Sachs Asset Management, Fidelity, TIAA-CREF and Wellington.

“We had to set out the story: why should we do this deal and why should they invest with us? But in the end, substantially all of the stock offering was built in, so we announced the deal and the financing pretty much simultaneously,” McNeill said.

“One minute the window is open and then one minute it’s shut, so there was a concern to get it all put together. There’s just so much risk when you’re doing a deal this big. Setting out the right expectations is very important when you are trying to raise $1 billion. There was a lot of paper-pushing required.”

Analysts’ views

Canaccord Genuity analyst Sam Burwell said in a report that if RSP deploys the rigs it said it will, the deal ends up being accretive to net asset value and will look even better later than it does now. It was a big chunk for a company with a market cap of $4.2 billion at the time.

“The area’s attractiveness stems from the depth, thickness and pressure of the Wolfcamp and Bone Spring formations in the area. RSP says it expects each well to yield an EUR of about 1 million boe,” Burwell said.

Gray said 2017 production will be 80% to 90% above 2016 due to the acquisition and then RSP guides toward 30% to 40% growth in 2018 and 2019, the kind of growth in a premier basin that analysts salivate over.

“RSP’s acquisition checks all three boxes,” said analyst Subash Chandra of Guggenheim Securities. “One, rate of change potential; two, significant Delaware exposure; and three, a position along the core stateline area. We believe this is a compelling entry point. Silver Hill is a game changer in our view.”

Gray said he believes any significant deal, especially one of this magnitude, takes a few months to digest and integrate. However, he’s already fielding inbound phone calls from neighbors about acreage swaps or trades, and he indicated he might do a few bolt-on purchases as well. Meanwhile RSP’s 2017 budget will be double that of last year, at $600 million to $625 million. By the end of the year he hopes to have four rigs running in the Midland Basin, as they are now, and four in the Delaware, versus two now.

In the Midland Basin, RSP was drilling some wells with 10,000-foot laterals, Gray said, although its sweet spot is more likely 7,500. But that technical prowess will now travel west to the Delaware. “You’ll see us move more in the direction of 7,500 although occasionally we’ll try 10,000 again.”

The company is also working on optimizing its completion design and getting the amount of proppant intensity right. “You can pump more sand and make a bigger well, but you’ve still got to make a profit,” Gray said. “We’ve done as much as 2,500 pounds per foot, so we’ll see where that leads.”

There is a lot of infrastructure work to do before RSP can accelerate drilling in the Delaware. Saltwater disposal wells need to be planned, production facilities such as tank batteries need to be expanded, and pipe needs to be laid to reduce truck traffic. The electrical grid is immature there, in Gray’s words, and needs to be addressed.

Pipelines and processing are not big worries. In January, Targa Resources Corp. announced it will buy Outrigger Energy LLC for $1.5 billion, and will gather the crude oil and gas. Gray said RSP already has a good relationship with Targa. (Coincidently, Silver Hill I owned 50% of Outrigger’s Delaware system.) Also in January, Plains All American Pipeline LP announced it will acquire the Alpha Crude Connector from Concho Resources Inc. and Frontier Midstream Solutions for $1.2 billion. The line runs across RSP’s acreage in the northern Delaware.

Plains CEO Greg Armstrong has said he believes overall Permian Basin crude output will rise as much as 50% in the next two or three years. Now RSP Permian will be part of that growth.

Said McNeill, “We identified Silver Hill early on as one of the cherries on top.” Done deal. Miller said it was a pleasure to transact with old friends he trusts; a number of his employees will join RSP. “It was a fantastic outcome for our investors.” No doubt he will reload and surface again.