Why Linn Energy's Asset Swap Is a Win-Win

Earlier this week Linn Energy  (NASDAQ: LINE  ) announced that it made a deal with Devon Energy (NYSE: DVN  )  which would include a swap of its 70,000 net acre position in the Granite Wash Play in the Texas and Oklahoma panhandles in exchange for Linn 896,000 dry-gas producing acres in five separate locations. On the map below, acreage acquired by Linn is marked in beige.

Linn Energy Investor Relations

Here is a breakdown of the acreage Linn will receive:

  Net Acres

Approx. 

Production

(MMcfe/d)

Current Well Count Decline Rate
Rockies 396,000 147 1,990 12%
Mid-Con/Hugoton 96,000 36 530 15%
East Texas 121,000 45 630 14%
South Texas 154,000 37 580 16%
Louisiana 129,000 10 150 14%
Total 896,000 275 3,880 14%

As you can see, almost half of both the acreage and production Linn will receive is in the Rockies. Since, right now, oil offers much higher returns than does gas, one might wonder why Linn is trading its oily assets away like this. The reason Linn is doing this swap is to lower its overall decline rate: As a master limited partnership, or MLP, Linn's goal is to maximize cash flow and return that cash flow to shareholders.

One of the biggest concerns of any MLP is how much is needed to spend in order to maintain production levels in any given oilfield. "Maintenance capex" comes right out of distributable cash flow. Generally, the higher the decline rate, the higher the maintenance capex will be. Therefore, properties with higher decline rates, even if growth prospects are promising, tend to be inappropriate for an MLP portfolio. 

When compared to some of Linn's other assets and recent trades, the 14% decline rate in this new Devon acreage seems quite high. For example, in California and the Permian, the decline rates are low-to-mid single-digits for much of Linn's acreage. Recently, Linn also swapped Permian shale acreage for gassy acreage in the Hugoton Basin which has an average decline rate of just over 10%.

However, while Linn hasn't disclosed decline rates of its Granite Wash acreage, other drillers in this play typically report an initial decline rate of between 50% and 80%; much higher than that of the acreage Linn is acquiring. 

Rig in the Rockies. Photo by Tony Bynum. 

A win-win
The Granite Wash has been a disappointment for Linn. Back in 2012 and 2013, disappointing well results in this shale play led management to de-emphasize the region. For example, in 2013 management devoted 38% of its capital budget to the Granite Wash. In 2014, however, spending was cut to just 11% for this region. 

Devon probably thinks it can do better in the Granite Wash, and frankly, I also believe that it can. As an upstream MLP, Linn's expertise is in exploiting mature fields. Devon's expertise, however, is in shale oil. In its newly acquired acreage Linn sees over 1,600 total future drilling opportunities, 600 of which are in areas already drilled by Devon. Conversely, Devon likely sees additional shale opportunities in drilling areas missed by Linn. That's how this deal is a win for both parties.

Foolish takeaway
Linn's acreage swap with Devon is part of a larger plan to reduce capital intensity in its operations, thereby freeing up capital and increasing the partnership's distribution coverage ratio. Devon, for its part, got a good deal on shale acreage which it believes it can successfully develop. Those long Linn Energy should look forward to next quarter's conference call, as we will get better information on just how much this deal effects the distribution coverage ratio and possible future distribution growth. 

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 02, 2014, at 2:35 PM, JustMee01 wrote:

    It's not a simple asset swap. LINN acquired Devon assets and simultaneously announced its intention to divest Granite Wash properties to pay for the acquisition. $2.3B in temporary financing was arranged as bridge financing to allow LINN time to sell that Granite Wash acreage. The other half of the 1031 exchange is yet to happen.

    "LINN Energy, LLC (Nasdaq:LINE) ("LINN" or "the Company") and LinnCo, LLC (Nasdaq:LNCO) ("LinnCo") announced today that LINN has signed a definitive agreement to acquire assets in five U.S. operating areas from Devon Energy Corporation (NYSE:DVN) ("Devon") for $2.3 billion.

    LINN plans to sell its position in the Granite Wash and Cleveland plays located in the Texas Panhandle and western Oklahoma.

    LINN has secured $2.3 billion of committed interim financing for the acquisition of Devon assets, subject to final documentation. The financing was lead arranged by Scotiabank and included Barclays, RBC Capital Markets and Wells Fargo."

    http://ir.linnenergy.com/releasedetail.cfm?ReleaseID=857077

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