Is LINN Energy Overpaying Just to Get the Berry Deal Done?

Investors are prone to fall prey to certain biases that impact how we react to news. These can make us terrible investors as we can sometimes frame new information in the wrong way. This causes us to react instead of digest. It's why we see such volatile reaction to earnings and other announcements.

Depending on our bias, we will all react differently to the latest news from LINN Energy (NASDAQ: LINE  ) and its affiliate LinnCo (NASDAQ: LNCO  ) to amend the merger agreement with Berry Petroleum (UNKNOWN: BRY.DL2  ) . The companies are increasing the exchange ratio of 1.25 shares to 1.68 shares. My first reaction to seeing that news was that LINN is now overpaying just to get the deal done. Maybe it is. However, I need to clear my bias and look at the deal as it is today, and not how it was first announced.

As investors we tend to anchor, especially on price. For months many of us thought LINN and LinnCo were getting quite a good deal. Especially given that LINN's units and even more so LinnCo's shares were pretty fully valued when the companies made the share exchange offer for Berry Petroleum. Today, however, LINN and LinnCo are paying about $600 million more than the original offer.

There is no denying that $600 million is a lot of money. It's more than LINN recently paid to increase its position in the Permian Basin. LINN could have used that money to make another similar acquisition. However, at the same time $600 million is the exact amount that Berry Petroleum will have spent this year on its 2013 capital spending plan. It is that capital which has boosted Berry's production to the point where it expects to exceed its original production guidance set for the year.

The frame of reference that investors need to make here is that Berry Petroleum has quietly performed quite well this year. It recently posted outstanding third quarter results. So, the Berry Petroleum that LINN is buying today is an even better performer than the one that LINN originally offered to buy in February. LINN's CEO Mark Ellis even made reference to this in the press release announcing the amended merger agreement. He noted that, "Since initially engaging with Berry, their operations have consistently outperformed expectations, which is evidenced by their recent third quarter 2013 results." Clearly, there is a case to be made that Berry's performance this year has made it a more valuable company.

The other part of the equation that investors need to frame into the new reference point is the value that oil rich assets are trading for these days. Take for example Ultra Petroleum's (NYSE: UPL  ) recent deal to acquire an oil rich asset in the Uinta Basin. Ultra Petroleum is paying $650 million for oil production that amounts to 4,000 barrels of oil per day. That's about half the production Berry Petroleum is currently seeing at its position in the Uinta. It suggests that the value of assets in places like the Uinta Basin are more highly prized than before. That same argument can be made for the Permian Basin as well as deals there are getting pretty rich.

Bottom line is that Berry's oil rich assets are worth more today than when the deal was first struck. Are they worth $600 million more? It's hard to make a case that it's not worth that much, especially to LINN Energy.

Remember, LINN Energy only really grows by acquisition. It developed LinnCo to be the vehicle it uses to gobble up C-corps like Berry Petroleum. That's why LINN Energy needs this deal to close even if it's costing more to do so. While the deal isn't as sweet to LINN or LinnCo investors it is a key deal to the long-term growth of the company, which is hard to put a price tag on. So, while I don't like the fact that LINN had to increase its offer, it needed to be made to seal the deal.

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  • Report this Comment On November 04, 2013, at 11:15 AM, timmnsa wrote:

    Hmm. Sell 250 LNCO at 34, buy 161 BRY at 52.75.

    161*1.68=270.

  • Report this Comment On November 04, 2013, at 11:27 AM, zorro6204 wrote:

    That's an interesting argument, that Berry has done a lot of work since the deal was first announced. Of course, they did it with money, and those dollars are off the table too.

    I think LINE agreed to this just to clear the decks, get rid of the overhang. I guess BRY stockholders can thank Barron's and Hedgeye for the extra bucks, probably this deal would have closed long ago at the original terms without the controversy.

    So, they broaden the base, get oilier and have some new ground to drill, that's positive. But I assume the $3.08 distribution is not going to happen anytime soon.

    I see this as costing about $5 in the unit price of LINE in the market over the next couple years, but that's $5 that never would have existed without the deal going through. At least the drama is gone, and the unit price can start to heal over time.

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