Viper Energy Partners’ ample free cash flow will provide a cushion for bondholders, but oil prices could hinder the MLP’s growth if its operators slow their drilling activity, according to five sources following the company. The issuer owns mineral and royalty interests that are operated by E&Ps, including its ultimate parent, Diamondback Energy.

“It’s the operators that develop their acreage that determine the growth. If they decide to not drill as much as they planned, EBITDA falls,” one of the sources said. “So you have no capex, but if the development plans fall through, you have no growth.”

Led by Credit Suisse, Viper is marketing a B1/BB+ rated USD 400m senior unsecured notes due 2027, whispered in the mid-5% area. The roadshow is expected to run through tomorrow (10 October), with pricing expected after.

Proceeds from the deal will repay revolver borrowings. Pro forma the deal, Viper is 2.2x levered, based on LTM consolidated adjusted EBITDA of 265m and total debt of USD 586.5m.

With a shortage of drivebys and limited cross-border roadshows, Viper is one of the only names in the market right now to satisfy investor appetite for higher-quality paper, said a sellsider.

“People are reaching for non-cyclical names and if they can’t get that, then they’re settling for higher-quality names in cyclical sectors, like Viper,” the source said.

Diamondback formed Viper in February 2014 to own, acquire and develop oil and natural gas properties. Viper focuses on properties in the Permian Basin and Eagle Ford Shale. Diamondback still controls Viper through 100% ownership of Viper’s general partner and 60% ownership of Viper’s limited partnership (LP) units, and is expected to remain a key partner.

On 1 October, Viper completed the acquisition of mineral and royalty interests from subsidiaries of Diamondback for USD 190.2m of cash and equity, according to deal documents. The company also acquired assets from third-party sellers for USD 193.6m, funded by drawing on the revolver and cash on hand.

Pro forma liquidity stands at USD 545.3m, comprising USD 6.8m of cash and USD 538.5m of revolver availability.

Including the newly acquired assets, Diamondback operates roughly 51% of Viper’s acreage, according to deal documents.

Sources view Diamondback’s involvement as largely positive. Among the spectrum of E&Ps, the Ba1/BB+ rated Diamondback is considered one of the more conservatively managed and low-cost operators, three of the sources said.

The proposed bonds should price wide of Diamondback’s existing notes since it’s Viper’s debut issuance and accounting for three additional years of exposure compared to Diamondback’s 2024 notes, sources said. Diamondback’s Ba2/BB+ rated USD 1.25bn 4.75% senior unsecured bonds due 2024 last traded today at 102.625 to yield 3.831%, in line with recent levels, according to MarketAxess.

Still, looking ahead Diamondback will likely funnel Viper’s extra cash flow into the parent if oil prices take a major hit and Diamondback’s own cash flow becomes constrained, the sources said.

Oil prices have trended lower in the last month with WTI crude quoted today at USD 52.67 per barrel, compared to a recent high of USD 62.90 per barrel in mid-September and USD 58.64 per barrel at the end of September.

A conservative estimate for free cash flow in 2019 and 2020 – not baking in any projected growth from recent acquisitions – hovers around USD 215m-USD 220m (around 37% of total debt). That’s considering USD 265m of adjusted EBITDA, less USD 5m of SG&A costs, USD 15m-USD 20m of severance taxes and USD 30m of pro forma interest expense.

Investors also pointed to the long-standing concern of oversupply in the Permian Basin and a drilling slowdown in response as a hurdle for Viper.

“Growth is going to be slower than people think, because it depends on how much the Permian is going to get drilled up in the short term. A lot of these E&Ps have resolved to decrease drilling to avoid cost overruns until oil prices bounce back up for the long-term and who knows when that will happen,” one of the sources said.

A representative for Viper did not respond to a request for comment. Credit Suisse declined to comment.

2019 Debtwire