Upstream exploration and production companies face a difficult task. Not only do they have to worry about effectively developing their existing assets, but once those assets are depleted, they also have to worry about finding new assets for continued growth.
That's why many upstream master limited partnerships resort to mergers and acquisitions to quickly and easily pursue growth. The latest buyout comes from BreitBurn Energy Partners (NASDAQOTH:BBEPQ), which announced a takeover of smaller rival QR Energy (UNKNOWN:QRE.DL).
In a $3 billion acquisition, BreitBurn will instantly become the largest oil-weighted MLP. The deal makes a lot of sense for BreitBurn, as it fulfills several of the company's key strategic priorities and will offer meaningful operating advantages going forward.
Here's what BreitBurn saw in QR Energy and why it's a great move.
Going long on oil
BreitBurn's ambition is to focus even more on oil. After bringing QR Energy's assets into its portfolio, BreitBurn will become the largest oil-focused upstream master limited partnership. Roughly two-thirds of QR Energy's reserves are oil, higher than BreitBurn's 53% oil exposure. Now, the combined company will have access to a number of premier oilfields across the United States.
This makes sense, given BreitBurn's track record of success in its oil operations. Second-quarter oil production increased nearly 6%, which was better than the overall company's 4% production growth quarter over quarter.
Going forward, this will improve even further. QR Energy's portfolio brings in high-quality assets. Two-thirds of the properties are liquids, which are higher-margin products. The assets are long-lived with shallow rates of decline. The assets being acquired hold a 15-year proved reserve life. This includes acreage in the Permian Basin as well as significant positions in California, Texas, and Oklahoma.
QR Energy is in high-growth mode. Second-quarter average production and distributable cash flow increased 8% and 13%, respectively, from the previous quarter. Part of the reason is QR Energy's operational execution. It realized an average price of $98 per barrel last quarter, higher than BreitBurn's $95 per barrel.
And, the deal presents significant synergies as well. BreitBurn will be able to eliminate duplicate costs since it's already involved in many of the same fields, and obviously the same industry, as QR Energy.
Because of all of this, BreitBurn management believes that the deal will be immediately accretive to both its net asset value and its distributable cash flow. The latter is what unitholders are primarily concerned with since upstream MLPs like BreitBurn fund their distributions from DCF.
As far as distributions are concerned, investors have little to worry about. The deal will be immediately beneficial to BreitBurn's distribution, which is already a hefty 9%.
Acquisition to help fuel distribution growth
Separately, BreitBurn is acquiring the additional properties to keep producing oil and gas, which obviously finances its hefty distributions. Upstream oil and gas companies need to constantly search for, and acquire, new assets for development to help offset depletion of their existing assets.
In addition to announcing the acquisition, BreitBurn also announced it will increase its distribution to at least $2.08 per unit, up 3% from its previous level.
An even higher distribution raise isn't out of question because the total synergies realized may be greater than management is initially anticipating. The company will benefit from a reduced cost of capital and a strengthened portfolio, which could leave the door open to another distribution bump down the road.
The bottom line
BreitBurn Energy saw an opportunity and seized upon it. Management deserves a lot of credit for making a wise acquisition. By absorbing QR Energy, BreitBurn instantly solves its quest for valuable, mature assets.
The deal will not only immediately boost production, but significant cost savings will help the bottom line as well. This will easily allow BreitBurn to modestly increase its distribution, which is the primary concern for upstream MLP investors. And, thanks to continued benefits, there's room for an even more generous distribution down the road.
Add it all up, and BreitBurn investors have plenty of reason to be excited about future growth.
Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends BreitBurn Energy Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.