BreitBurn Energy Partners (NASDAQ: BBEP ) just made its biggest acquisition of the year. Yesterday the partnership announced that it would acquire fellow upstream master limited partnership QR Energy (NYSE: QRE ) for $1.46 billion. This acquisition was an all-stock deal, where unit holders of QR will receive 0.985 shares of BreitBurn for each share of QR. The combined partnership will have an enterprise value of $7.8 billion, which is second only to Linn Energy (NASDAQ: LINE ) among upstream master limited partnerships, or MLPs.
Dark blue represents BreitBurn acreage. Light blue represents QR acreage. BreitBurn Investor Relations
Pros and cons
This recent acquisition represents a deviation from BreitBurn's usual strategy of picking up acreage parcels individually, like it did with Whiting Petroleum (NYSE: WLL ) and the Postle acquisition. What does BreitBurn get from QR? Well, for one, BreitBurn will receive strong acreage in the Permian and Ark-La-Tex regions, acreage which management of QR already identified as having significant additional drilling opportunities.
BreitBurn gets some geographical diversification, too. Not incidentally, pro forma BreitBurn's biggest single position is now the Permian Basin. The Permian generally has basin reservoirs with among the lowest decline rates and among the lowest cost-bases. In addition to basin oil, the Permian is also home to the Wolfcamp/Spraberry shale, which could contain a tremendous reserve of oil that could be harnessed through horizontal drilling.
This deal is immediately accretive to BreitBurn unit holders: Management believes it should see at least a 3.5% distribution increase as a result of the transaction.
But was QR really worth acquiring? QR's distributable cash flow, or DCF, was only 1.0 times distributions last year, which leaves little margin for error. In addition, QR's debt sat at around 4 times earnings before interest, taxes, depreciation and amortization, or 4 times EBITDA. Most upstream MLPs have debt to EBITDA ratios of between 2 and 3 times. A naysayer might claim that BreitBurn bought a clunker, here.
Furthermore, the price BreitBurn snatched QR at is no bargain. Management paid a 19% premium.
Right now, I believe investors should be lukewarm to BreitBurn's deal with QR. There are certainly merits for the deal: The complementary nature between QR's and BreitBurn's acreage, along with the synergies to be realized, make the deal a worthwhile one. However, BreitBurn also paid a fairly high price considering what is being acquired here.
In a few years' time, this deal will look like a great one under a few circumstances. Currently, there is a 'wave of horizontal drilling' washing over the Permian. While BreitBurn focuses on the more traditional vertical drilling, the partnership may have many new opportunities to lease horizontal drilling rights as a result of the QR acquisition. That could lead to some huge benefits down the road.
Also, this acquisition looks much better if it leads to future 'bolt-on' deals in some of QR's strongest acreage positions. Specifically, this would include oily 'bolt ons' in the Permian, the Jay Field in Florida, and the Ark-La-Tex region.
Merely a day after its announcement, the merits of the acquisition of QR Energy is still up for debate. I believe that there is a lot to like about this acquisition, but it is important for investors to think critically about it as well. Was this acquisition a good one? At this time, it may be too early to say.
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