This morning, Linn Energy (LINE) announced it had reworked its deal for Berry Petroleum (BRY). Shareholders of Berry will now receive 1.68 shares of Linn Co (LNCO) for each share they own instead of the prior 1.25 exchange rate. Linn will now have until the end of January to close the deal with an expected vote date in mid-December. Linn management will also hold a conference call tomorrow morning at 11 a.m. Eastern to discuss this deal and likely answer questions about its most recent quarterly results, released last week. The press release announcing the revised deal can be found here.
Given the premium BRY shares had been trading to the deal price, an increase in the exchange rate was widely anticipated and will make this deal less accretive. In fact, when the deal was originally announced, Linn suggested it would increase the distribution by $0.40. In the new press release, no exact figure is given, though the company confirms the deal will be accretive. However, it is clear that this deal is far more costly for Linn shareholders.
With the increased exchange rate, Linn will have to issue an additional 23.4 million shares, which will dilute existing shareholders by an additional 9.9%. Assuming Linn was accurate that under the original deal, the distribution would increase by $0.40, the increased dilution results in distribution growth of $0.16. The increased exchange rate erases 60% of the accretive nature of this deal, though it still will be accretive, based on Linn's original math. This would increase Linn's distribution by 5.5%, all else equal.
Before the SEC inquiry into Linn's accounting had been disclosed, shares of LINE traded at $33.29. Trading up on the news of the amended deal for Berry, Linn shares are now only 5.2% lower than they were before the accounting issues. However, the additional dilution has decreased the potential distribution by 7.3%, which would suggest that shares of Linn have more than fully rebounded.
Investors should also be aware that Linn is not purchasing Berry at a bargain price anymore. While Linn forecasts Berry will add 30% to Linn's production and 33% to Linn's proved reserves, Berry will add 38% to Linn's market value, which means production and reserves per unit will actually decline while adding another $2 billion in debt to an already highly indebted Linn Energy. As such, under the new framework, there is reason to doubt that Berry will actually be accretive to Linn shareholders in the long run. Linn is hoping some of Berry's "possible" reserves pan out, but if they do not, Berry will turn out to have gotten the better end of this deal.
Therefore, Linn unitholders should be happy that the accounting issues appear to be behind the firm, though it still must address fundamental problems of spending too much on cap-ex for too little revenue growth and a distribution coverage ratio that has been far from satisfactory this year. Based on results over the past six months, Linn cannot sustain a $2.90 annual payout, so Berry may not actually lead to a higher distribution, just a better coverage ratio at the current distribution. At the same time, by increasing the exchange rate for BRY, Linn has lost much of its forecasted accretion, and by paying more for Berry's production and proven reserves than the market values its own, the long-term accretive nature of the deal is in question. With shares at only a 5% discount to the day before the SEC inquiry was announced, despite a potential distribution that has fallen by at least 7.3%, investors may want to consider taking some profits and looking into other E&P names.