FANG or FANG?
That's the question I've been asking myself. As the media fixated on the machinations of Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google (Alphabet, GOOGL) Thursday I couldn't help staring at the chart of another FANG. That's the symbol for independent E&P Diamondback Energy. Diamondback shares rose 5.3% Thursday, buoyed by the rally in the energy sector. (Facebook and Google are part of TheStreet's Action Alerts PLUS portfolio. Amazon is part of the Growth Seeker portfolio.)
That rise was most unlikely given that Diamondback priced a greatly upsized common share offering after Wednesday's close. Diamondback sold 4 million shares -- the initial filling was for 2.25 million shares -- at $56.50. That's right, FANG closed a major follow-on offering on the day the stock hit a 52-week low. Why? Well, partly to show it could.
The No. 1 differentiator in oil and gas in these turbulent times is access to capital. It's always been an important factor, but now it's almost the only factor.
So though it would seem to contradict the laws of supply and demand, Diamondback's ability to raise incremental equity capital actually increased the value of its existing equity capital. Obviously FANG and its banker, Credit Suisse, couldn't have known that Thursday would see such a strong rally in the energy sector, but those who were allocated shares Wednesday have already made a handsome profit.
Diamondback's press release noted that the company would "use the net proceeds from this offering to repay the outstanding borrowings under its revolving credit facility, with the remaining net proceeds to be used to fund a portion of its exploration and development activities and for general corporate purposes, which may include leasehold interest and property acquisitions and working capital."
Diamondback only had $10 million drawn on a revolving credit facility with a capacity of $500 million on Sept. 30, so even if the company financed all its capital expenditures for the fourth quarter from the revolver, there would be at least $100 million left from the offering to fund future expenses.
That's right, FANG is using equity, not debt, to finance its growth.
Even though that statement probably made some Houston-based investment banker's head explode, it's true and it's prudent. The high-yield market for energy is absolutely brutal these days -- as energy is being blamed for all of the junk bond market's malaise -- and the few deals that are getting done now in the energy high-yield market are mainly of the debt-exchange (i.e., desperation) variety.
So Diamondback's decision to finance its growth using equity instead of debt is a prudent one. Don't forget that Diamondback came public on Oct. 11, 2012, at $17.50 per share. So while an uninformed observer might view doing an equity deal at $56.50 as odd given that FANG shares were trading in the high $70s as recently as November, looked at in the longer term, the deal made much sense.
There are plenty of other operators in FANG's core Permian area of operations who can't raise equity, are watching in vain as 2015 hedges have expired and 2016 hedges are impossible with WTI struggling to hold $30 a barrel, and whose lenders control their futures as debt payments are impossible with cash flows hampered by low commodity prices.
At some level, most other players in the oil patch are sellers, and Diamondback -- along with the supermajors and a very small group of unlevered independents -- now has fresh capital to buy in what is a once-in-a-generation buyers' market.
Longer term, those acreage purchases will pay off handsomely for FANG just as the decision to buy Diamondback shares on its IPO -- "horizontal drilling ... what's that?" -- has paid off for early investors even as oil prices have endured a slump longer than any in recent history.