Seeking Alpha
Research analyst, value, growth, newsletter provider
Profile| Send Message|
( followers)  

Introduction

Linn Energy (NASDAQ:LINE) has an ambitious goal to provide a safe and increasingly large distribution to its unit-holders by growing their upstream petroleum business. My earlier analysis indicated that LINE has been more successful than most high-dividend payers in increasing production and proven reserves per unit but with a price of large and increasing debt.

Linn Energy has indicated that buying Berry Petroleum (NYSE:BRY) will increase value for unit-holders. They are so confident that they have already given notice that they will increase distributions to unit-holders when the deal closes. That seems unusually shareholder friendly. LINE is offering 1.25 units of Linn for each share of BRY (indirectly through LinnCo) and to assume over $2 billion in Berry's liabilities.

To understand LINE going forward, it is going to help to understand what they are getting when they buy BRY. I set out to find what benefits there'd be to Linn Energy unit-holders and how long that benefit is likely to last. Others will surely think of some other way to do the analysis and I look forward to their articles on Seeking Alpha.

Long-Term Growth

Presumably, Linn Energy is in the process of buying Berry Petroleum as a low-cost way to add production and reserves, presumably at lower cost. I come to that conclusion because LINE is not only paying BRY a premium, they are promising to be able to increase the distribution paid for all unit-holders as a result of the acquisition. Let's compare the track records of Linn Energy and Berry since 2008 to see how well they have been doing.

The following table compares the Compound Annual Growth Rate (OTCPK:CAGR) for the two companies from 2008 through 2012. I have calculated the data for both the overall totals (because that is the way companies usually report data) and the more relevant "per share or unit" data.

CAGR since 2008

BRY

BRY/ share

LINE

LINE/ unit

Reserves at year-end

2.80%

-2.21%

30.37%

12.80%

Production per year

6.15%

0.09%

33.38%

15.26%

Distributable Cash

11.84%

6.27%

-11.99%

-23.88%

Non-acquisition Capex

14.19%

8.52%

32.29%

16.24%

Long-term Debt

10.09%

4.49%

38.23%

19.58%

LINE has far outperformed in both production and reserves. BRY does better increasing its cash flow, probably because they have a more oily mix. LINE is increasing capex at a much higher pace and their faster growth of debt tells you how they pay for that capex.

Assuming both companies have competent management and access to capital at the same interest rates, it is logical to guess that LINE's superior performance in reserve and production growth may be a function of the differences in their resource base.

Pro Forma Comparison

Instead of only considering the longer-term track record of growth, perhaps it will be more enlightening to compare the 2012 operational results of LINE and Berry and what they would have been in 2012 had the acquisition occurred on Dec. 31. 2011.

In the Table, there are two entries for BRY; one is the data they reported in the 2012 10K and the other is their "per share" business metrics based upon LINE paying 1.25 units for each BRY.

There are also two entries for LINE: 1 for Linn Energy results in the 2012 10K and the other, as if Linn and Berry had been combined for all of 2012. In that way, in a gross way, you can see what they'd look like when merged. Of course, LINE will not run the company the same as BRY did, but they will be constrained to some extent by the assets.

Keep in mind that I am NOT analyzing the companies as a whole, but their performance per share or unit.

Pro forma Value:

2012

BRY acquisition by LINE

2012

Pro forma Value:

combined value

10K

Metrics Comparison

10K

BRY priced

BRY+LINE

LINE

per share or unit unless otherwise noted

BRY

by LINE

272884

203775

Fully diluted shares (1000s)

55287

69109

23.62

23.54

Proved Reserves (Mcfe)

29.86

23.89

15%

20%

YOY Reserves Growth

-2.0%

-1.6%

1.19

1.20

Production (Mcfe)

1.45

1.16

40%

53%

YOY Change: Production

0.15%

0.12%

$ 3.02

$ 2.62

Cash available/Mcfe

$ 5.26

$ 4.20

$ 6.31

$ 5.13

Non-acquisition Capex expenses

$ 12.23

$ 9.78

24%

26%

YOY Change: Capex

26%

20%

-$ 0.81

-$ 1.92

Profit

$ 3.10

$ 2.48

$ 3.89

$ 3.15

Cash Available

$ 7.60

$ 6.08

$ 29.54

$ 29.63

total liabilities

$ 36.61

$ 29.29

25%

28%

added liabilities in year

20%

16%

$ 3.08 after merger

$ 2.87

Distribution or Dividend paid

$ 0.32

$ 0.26

45%

52%

% NG Reserves

25%

25%

RESERVES ACCRETION: Yes, but not on growth rate

The LINE acquisition of BRY is accretive to LINE on Proved Reserves by 0.08 Mcfe/unit. Tiny, but accretive. If Berry asset development continues as it has been going, they will reduce LINE's Reserves growth rate from 20% to 15% per year.

PRODUCTION ACCRETION: Not on Mcf, but it is in cash per Mcfe

Because of the relative NG and Liquids mix, the average free cash flow from each MCF or BOE will be higher for LINE after the merger, even though the actual production per unit declines a bit. Linn has been much more successful growing production, so Berry's minimal production growth is going to reduce LINE's overall production growth. That may be avoided with more capex and/or how it is deployed.

CAPEX: No

Even though Linn spends over a billion dollars on non-acquisition capex, Berry spends more on a per share basis, because of its lower share count. If the 2 companies had been combined in 2012, non-acquisition capex per unit would have been higher than it was for LINE alone. This certainly suggests that the reserve decline and the minimal production additions at Berry were not for lack of spending. Given the higher initial production and the resulting higher internal rates of return on some of LINE's best areas, it may pay to focus some of the Berry's cash flow on LINE legacy land and let the Berry production decline, given the decline rate is slower than LINE's.

LIABILITIES: Yes

If BRY has been part of LINE in 2012, the combined entity would have had lower debt per unit. In addition, the growth rate of the debt would have declined. Less debt per unit means each unit-holder owns more of the slightly increased reserves… an immediate result of LINE combining with Berry.

CASH AVAILABLE TO SPEND: Yes

Cash available to spend on capex and distributions would have been 23.5% higher if Linn had Berry cash flow in 2012. This is another significant gain for LINE in this deal. Part of that money is going to be spent on higher distributions so unit-holders will be happy.

PROFIT: Yes

LINE would have had a smaller loss in 2012 if it already owned Berry. This alone is usually enough proof to accept that a deal is accretive, but profits are not as crucial a measure in the petroleum business as Reserves, Production and Cash Available, all of which are accretive to the acquirer in this deal.

DISTRIBUTIONS: No

The promised $3.08 in distributions per year will cost an extra $256.67 million each year. Berry's Distributable Cash of $420.17 million would cover that with an extra $163.503 million available to put toward the increased capex requirement for the combined company.

Conclusion

When I pick apart the transaction, I can see that Linn Energy unit-holders are going to get a boost in reserves, production, and cash available to distribute. And they get higher dividends. Unit-holders are unlikely to complain.

Berry shareholders are getting a nice capital gain on their BRY shares and a substantial dividend raise from their 32 cents, with their new LNCO shares. They also exchange a share in a company that has been struggling to grow, for owning one that has been growing both production and reserves.

Looks like a Win-Win, to me.

And it looks like an obvious illustration of Linn Energy being unit-holder friendly, raising the distribution to give them some of the acquisition benefits.

Source: Linn Plus Berry: A Shareholder Friendly Deal