Seeking Alpha
Long-term horizon, research analyst, REITs, gold & precious metals
Profile| Send Message| ()  

Linn Energy (LINE) is a popular master limited partnership that pays a hefty monthly dividend yielding north of 11% from its oil and gas operations. It is somewhat of a battleground stock, with the bears saying it relies on acquisitions to grow and the dividend is unsustainable. Some have even likened it to a Ponzi scheme in some regard, although I think that's a bit harsh, as there was a unique analysis to support the argument. The bulls argue that LINE is growing at a healthy clip and the dividend will be sustainable as revenues grow with favorable oil and gas prices and continued expansion efforts. I recently opined that I believed that the stock could dip lower in the short-term in anticipation of upcoming expansion efforts, but that the stock is a good long-term purchase. While the current holdings of LINE are impressive, my long-term buy on the stock is predicated on one critical deal going through and it may be in jeopardy.

Properties

The company's current holdings are impressive and can sustain revenues and dividends, though perhaps not as high as shareholders are accustomed without growth. As most followers of the stock are aware, LINE's properties are located in the Mid-continent, the Hugoton basin, the Green River basin, the Permian basin, Michigan, Illinois, the Williston/Powder River basin, California, and East Texas in the United States. On its own assuming no growth from here, the company is still competitive. At the end of 2012, LINE boasted impressive proven reserves of 4,796 billion cubic feet equivalent oil, natural gas, and natural gas liquids; and operated 15,804 gross productive wells. However, it is on a path to two major deals of critical importance to the company's long-term growth. The first is a merger with Berry Petroleum (BRY) and the second is the expansion of its Permian Basin properties. In this article, I want to discuss what could happen with the BRY deal, and what it could mean for the company.

The BRY Acquisition Is Critical

As I write this article, LINE still awaits the Securities and Exchanges Commission's ruling on the fate of its large and complex deal with its affiliate company Linn Co (LNCO). This deal is for LINE to buy and acquire the assets of BRY for $2.42 billion, though total costs could exceed $4 billion. The deal is a huge catalyst for LINE/LNCO. Why is it so important? Well BRY is currently a publicly traded independent oil and natural gas production and exploitation company with operations in California, Texas, Utah and Colorado. As part of a deal such as this, LINE will assume all of BRY's debts and assets. BRY has impressive assets. BRY has over 3,000 producing wells covering more than 200,000 acres of land. What's more, these assets have relatively low-decline in quality/quantity and long-life. This fact makes it a low-risk, long rewarding play that is a decent fit for LINE's master limited partnership structure. Because of BRY's well and land locations, the deal will help LINE expand its growth into markets in California, Texas, the Permian Basin and the Uinta Basin. With BRY's annual production numbers, LINE could see an increase in production anywhere from 20%-40%. It should be noted that about three quarters of BRY's reserves are in oil and as such an acquisition will increase LINE's liquid oil exposure by approximately 16%-17% on a relative scale. For shareholders, it ultimately translates to the potential for the company to bring in a lot more revenue which could lead to higher more sustainable dividends, above the current 11.7% yield it currently pays. However, the deal will need final approval before it can move forward.

But The Deal Could Be In Jeopardy

What has grabbed the attention of shareholders of LINE, LNCO and BRY right now is a recent statement by BRY. BRY recently stated that the deal with LINE is the subject of an inquiry by the Securities and Exchange Commission and it will not be completed by October 31st. This means that after this date either BRY or LINE/LNCO can decide not to proceed with the deal. Management of BRY said in a Securities and Exchange Commission filing:

"There can be no assurances as to whether the parties will agree to extend the end date or that the parties will refrain from exercising their rights to terminate the merger agreement..."

This statement hit shares yesterday after hours and the pain has ramped up today as the shares are down another 4.5% figure 1).

Figure 1. Share Price Of Linn Energy In Last Two Days After Threat Of Berry Petroleum Deal Falling Through.

(click to enlarge)

This all began in the middle of the summer when the Securities and Exchange Commission initiated an inquiry into the deal. As such, the Securities and Exchange Commission requested documents regarding the transaction. However, the Securities and Exchange Commission also began to look into the as hedging strategies and certain financial aspects of LINE. This caused a wave of selling in the summer and led to several negative commentaries here on Seeking Alpha. To its credit, LINE has obliged with the informal inquiry and submitted all requested documentation in a timely fashion, though has been somewhat quiet on the matter with shareholders. We are now six days away from the October 31 "walk away" option date. If the deal falls through I think it is definitely a negative for LINE. It is strong on its own, but it does rely on acquisitions to continue growing. With BRY's assets, the deal is definitely critical to long-term growth. I believe the dividend really is dependent on continued growth. While the monthly policy gives LINE flexibility, without this deal it is likely to trend lower. If the deal doesn't go through, it could be a positive for BRY. Many BRY shareholders that have reached out to me via Seeking Alpha have stated they aren't thrilled with the deal. Given BRY's asset base has seen a growth in value here in 2013, being on its own the share price could move up substantially. Because BRY was locked into this deal, the stock has not really popped as one might expect like other players in the space.

My Take

I do not see a reason why the Securities and Exchange Commission would hold up the deal. There may be some further requests or additional terms and conditions built in, but I suspect the deal will go through. The risk however is that if it is delayed much passed October 31. As each day passes past October 31, the risk increases that one party backs out. In my opinion, this would be BRY, as shareholders would stand to gain somewhat being independent on a value basis. LINE and LNCO however need this deal. My long-term buy rating on the stock is likely dependent on this deal. I have opined that I believe there could be downside as the deal is not sealed. Should the deal fall, I wouldn't panic sell the stock, but I would expect shares to get punished as most expect the deal to go through. If it does not, all is not lost as the company could focus its efforts into expanding existing properties such as that in the Permian Basin.

Source: What If The Linn Energy And Berry Petroleum Deal Falls Through?