Deal Conditions Ripe for Energy Producers

Conditions may be ripe for a U.S. income stock deal in which high McDep Ratio Linn Energy (LINE), for example, offers shares for a low McDep Ratio royalty trust such as buy-recommended Hugoton Royalty Trust (HGT), hold-rated San Juan Basin Royalty Trust (SJT) or one or more of its peers. The spread in McDep Ratios from 1.2 for the prospective acquirer to less than 0.7 for the possible targets appears unusually wide for stocks with similar characteristics. The prospective acquirer can offer a premium to the target and score an increase in Net Present Value (NPV) per share if the deal can be completed. A reasonable offer need not be considered unfriendly as target unitholders who choose not to sell can continue to participate in the ongoing trust with the same trustee.

Today’s publicly held units of Mesa Royalty Trust (MTR) and Permian Basin Royalty Trust (PBT) are those which were not tendered in past acquisition attempts. Coincidentally the president and some of the top professionals at Linn are alumni of Burlington Resources which made the tender offer for PBT and once operated the underlying properties for both PBT and SJT. Linn’s motivation to do such a transaction would be to take advantage of its strength, a high stock price, to acquire cash flow that would better support its high debt and spread its high cost of talent over a bigger base. While the deal logic we outline may not lead to a transaction, it highlights the degree to which some high-quality income stocks are out of favor, a condition likely to change as investor confidence rebuilds.

Originally published on May 29, 2009.

Comments

[Energy Trader:]

What does the author mean by 'to acquire cash flow that would better support its high debt and spread its high cost of talent over a bigger base'?

HGT's dividend is less than 3 cents a month and SJT's is under a cent.

IMO - San Juan's dividend will continue to be under a cent for 4-6 months due to: 1)their properties are receiving very low gas prices $2.64/mmcf according to their last NR due to how far they are from market and 2) the dividend is based on April production.

So, it should be at least under a cent for 2 months as we May and June nat gas prices reflected in the dividednd. Since, I am very bearish on nat gas, I see a high possibility of storage filling up at the end of the summer, which would lead to continual lower prices for 2 months and then maybe 2 more months of increases to get back to where we are now. I believe in the long-term story of nat gas and that the time to buy will be in approximately 3-4 months. It may be even longer for SJT as they may indefinitely cut their dividend, I just do not see how they can support it.

Jun 23 12:11 PM

[einstein p ...:]

Natural gas prices are low by historical standards. The recently discovered additional 35% of reserves should increase the value of these companies and it seems as if natural gas is starting to catch on as the renewable energy source of choice, especially given recent geopolitical events in the Middle East. I'm not sure if I buy into the author's premise, but LINE and PBT both have good yields are not a bad place to park money in this market.

Jun 23 03:29 PM