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.