Linn Energy LLC (LINE) is an oil and natural gas acquisition and development company. The company's properties are located primarily in the Mid-Continent, the Permian Basin, Michigan, California, and the Williston Basin in the U.S. LINE opts to be taxed as an MLP. However, it has no IDRs (incentive distribution rights). Linn Co. (LNCO) is essentially a shell company that owns units/shares of LINE. Its raison d'etre is to convert LINE's LP distributions from ordinary income status to "dividend" status. If you want to receive ordinary dividends, you probably want to own LINE by owning LNCO. For those in higher tax brackets, this could be a significant federal tax advantage (20% vs. roughly 40%). There may be a significant state tax advantage as well.
LINE has been growing quickly, largely through acquisitions. In recent years it spent $1.37B in 2010, $1.51B in 2011, and $2.9B in 2012. LINE has approximately 4.8Tcfe in total proved reserves. 64% of the reserves are proved developed, 46% of the reserves are oil, and 54% of the reserves are natural gas. It has more than 15,000 gross productive oil and natural gas wells.
LINE announced on Feb. 21, 2013, that it just made its first big buy in 2013 -- a $4.3B purchase of Berry Petroleum (BRY), including the assumption of BRY's debt. The transaction is structured as a stock for stock merger of Berry Petroleum with LNCO. BRY shareholders will receive 1.25 shares of LNCO for each share of BRY, representing a value of $46.24 per share. This is to be followed by the acquisition of BRY assets by LINE. The transaction is expected to be tax free to Berry shareholders. For LINE shareholders it means the acquisition of some great assets that should help LINE to grow its dividend over the ensuing years. LINE expects that in the first full year following closing, the accretion due to the BRY acquisition will be in excess of $0.40 per unit. The current dividend is $2.90 per unit, so the dividend increase is expected to be approximately 13.8%+ (to $3.30+) on a per unit basis.
LINE plans to recommend to its board an immediate increase of 6.2% (or an increase to $3.08 per year) to the current distribution. LINE's recent Hogshooter successes should help it raise its dividend too. For the 26 wells it completed there in 2012, the average IP rate was approximately 2150 Boepd. This was comprised of 1500 bpd of oil, 385 bpd of NGLs, and 2.4 MMcf /d of natural gas. LINE plans to invest $400 million more in drilling the Granite Wash (where the Hogshooter is) in 2013. This amounts to 35% of LINE's development program excluding purchases. Including the BRY acquisition LINE plans to grow production by 45% in 2013.
This acquisition is expected to make LINE more "oily." BRY's production is approximately 40,000 Boepd with a decline rate of 15%. The reserves are approximately 75% oil. This will push LINE's liquids exposure from 46% currently to 54% after the deal closes. It should increase LINE's total proved reserves by approximately 1.7 Tcfe (or by 34%). Plus, LINE has identified 3.8Tcfe of probable and possible reserves in BRY's holdings. These should provide significant upside for LINE in the future. If you consider even half of the probable and possible reserves as proved, you find that the deal gives BRY at least another 3.5Tcfe of reserves. This is another 603+ million Boe. If you consider all of the proved, probable, and possible reserves, you get a figure of 948+ million Boe, or about $4.53 per barrel of oil equivalent.
If you add in BRY's debt of $1.615B, it brings the total cost of the deal to $5.915B. The per barrel acquisition cost figures are not as rosy, but they are still good. The numbers respectively for the two figures above would then be $9.8 and $6.2 per Boe of which about 75% is oil. For proved reserves alone the number is approximately $20 per Boe. This all seems a relative bargain to me. In fact my understanding is that the BRY proved, probable, and possible reserves may actually be greater than stated herein. Plus, some of the oil in California commands a price that is on average midway between the WTI and the Brent price. This will be an added bonus for profits. By comparison, high-flying Halcon Resources Corp.'s (HK) market cap values its proved reserves at approximately $47.8 per Boe. Continental Resources (CLR) -- a more typical growth oil company -- has proved reserves of 785 million Boe and an enterprise value of $18.1B. This values its proved reserves at approximately $23 per Boe. This still means the $20 per Boe LINE is paying for BRY's proved resources is a reasonable bargain.
The valuation is so reasonable that a law firm is now investigating the board of directors of BRY for a breach of fiduciary duty. Given the above comparison to CLR, it seems unlikely such a lawsuit will get very far. HK is just another momentum/HFT favorite with 8.5% short interest and a CEO with a great previous track record, Floyd C. Wilson. I am sure I can find companies that are valued lower than CLR relative to their proved reserves. Plus BRY has had trouble developing its resources with its already high debt level. A sale will allow a more financially solid LINE to develop those great resources.
Some extra good news is that both the EIA and OPEC have recently raised their forecasts for global oil demand in 2013. EIA raised its 2013 demand growth forecast by 110,000 bpd to 1.05 million bpd. Global oil demand is now expected to be 90.2 million bpd in 2013. OPEC raised its growth forecast by another 80,000 bpd to 840,000 bpd for 2013. These increased forecasts should help oil prices remain high even in a weak economic environment. This should help LINE/LNCO. Moody's also added its approval of this deal by revising its outlook for LINE to Developing from Negative.
All told this seems to be a great deal for LINE/LNCO. Its positive effect on the distribution/dividend payouts should make shareholders happy. LINE and LNCO are buys.
The two-year chart of LINE provides some technical direction for this trade.
Click to enlarge images.
The slow stochastic sub chart shows that LINE is neither overbought nor oversold. The main chart shows that the company has been in a consolidation pattern for the past two years. This great deal could see LINE break out of that consolidation pattern. If there is a U.S. recession, it may help LINE stay in its consolidation pattern instead of falling.
LINE has an FPE of 19.15. This should improve soon with the addition of BRY. It has a great historical growth record. The chart below shows some of LINE's recent CAGR's.
With the BRY deal, it doesn't appear that LINE has decided to rest on its laurels. As long as the U.S. economy doesn't go too deeply into a recession, the BRY acquisition should prove to be a terrific deal for LINE and LNCO. As I said above, LINE and LNCO are buys. However, you may want to consider that the overall market is currently overbought. Many pundits are predicting a 7% to 10% pullback soon. The sequester cuts issue has yet to be resolved. Those cuts could provide more downward pressure on the US equities markets. If the U.S. goes into recession in 2013, the market will likely go much further down. With this in mind, it is probably a good strategy to average into LINE and/or LNCO over the course of 2013. Then you should on average get a good entry price for it. Plus, you will get the great 7.53% dividend.
Note: Some of the above fundamental financial data is from Yahoo Finance.