While analysts and investors have been debating the merits of LINN Energy's (NASDAQ: LINE) hedging program, the company's management team was quietly putting together its largest and most creative acquisition to date. In addition to announcing its fourth-quarter and full-year earnings, LINN, by way of affiliate LinnCo (NASDAQ: LNCO), announced that it was acquiring Berry Petroleum (NYSE: BRY) in a $4.3 billion deal. Let's drill down and see what this deal means for investors.
The deal structure
This is the first time that an upstream LLC or MLP has ever acquired a C-Corp, so you'll notice that the deal's structure is very unique in its nature. Typically, LINN will purchase mature oil and gas assets from an exploration and production company for cash. This time it's LinnCo doing the buying, and its using its shares as the currency in this all-stock transaction.
The deal, which is structured as a tax-free deal for Berry investors will come in two stages. First, LinnCo will exchange its shares for shares of Berry and assume its debt. From there, LINN will acquire the operating assets of Berry from LinnCo in exchange for units of LINN. Those operating assets will provide a huge boost to the company's most important metrics.
How it affects LINN's operations
The acquired assets significantly boost LINN's operations across the board. LINN's acquiring around 3,200 long-life, low-decline producing wells on more than 200,000 net acres. Those acres are located in LINN's core geographies of California, the Permian Basin, East Texas, and the Rockies, as well as adding a new core area to the fold in the Uinta Basin.
The assets will add 240 million cubic feet equivalent per day of production, boosting LINN's current production by 30%. More importantly, in today's low-price environment for natural gas, these assets shift LINN's proved reserves firmly onto the liquids side of the equation. Berry's reserves, which are 75% oil, now shift LINN's reserve mix to 54% oil and liquids, which is up from 46% before the deal. Total reserves are boosted by 1.65 trillion cubic feet equivalent, or 34%, with additional probable and possible reserves of 3.8 trillion cubic feet equivalent in future upside potential. When you add it all up, the acquired assets add significantly to LINN's operations which also have a positive affect on its financial metrics as well.
How it affects LINN's finances
Because this is an all-stock deal, LINN's financial metrics, especially on the debt side will be greatly improved. LINN expects that the deal will trigger the change of control provisions on Berry's senior notes, which LINN then will repay using its credit facility or refinance at a lower rate. The company expects the rating agencies to view the deal as a credit positive.
The company's financials are further strengthened by the underlying cash flow of the acquired assets. They are highly accretive which improves LINN's distribution coverage ratio. With this being a key metric for MLP-type investments, its improvement is a big win for LINN investors.
How it affects LINN's distribution
The transaction is so accretive to distributable cash flow that it will boost it by $0.40 a unit. This has given management the confidence to recommend a distribution increase once the deal closes. LINN Energy investors will see their payout rise 6.2% from $0.725 a unit to $0.77 after the deal closes. LinnCo investors will fare even better as the company now estimates it won't have any additional tax liability this year. Therefore, LinnCo investors will see an 8.5% pay raise to that same $0.77 rate.
Even with the distribution boost, LINN's distribution coverage ratio will improve from the 1.07 times it was at the end of the fourth quarter of 2012 to 1.2 times when the deal closes and the increase goes into effect. It expects that ratio will improve further in 2014 and 2015 likely leading to future distribution increases. A final change that is still in the works has management looking into adjusting the frequency of its distributions from quarterly to monthly.
How it affects the future of LINN Energy and LinnCo
The deal for Berry Petroleum is a game-changing deal for the energy industry and for LINN Energy. Not only was it a bold move, and another first for the company, but it improved all the metrics that mattered most with one stroke of the pen. Now, with LinnCo as a viable acquisition currency, LINN can continue its hunt for more accretive deals.
Management, which said on the conference call that it will pursue more deals of a similar structure in the future, doesn't appear to be done shopping. LinnCo really adds to the firepower it already had by using LINN Energy equity and debt to buy assets directly from an exploration and production company. Now LINN can pursue the structure that will make the most sense by looking at transactions that accrete the most cents to its distribution.
Foolish bottom line
It's an exciting day for LINN and LinnCo investors. The company emerges from this deal with stronger, more diverse operations as well as a greater focus on liquids. Even better, LINN significantly improved its financial metrics by improving its debt profile and distribution coverage ratio. When you add it all up, LINN really hit it out of the park with this deal.