For people who have followed Linn Energy (LINEQ), these past few months seemed all quiet on the acquisition front for a company that has done so much wheeling and dealing. Then, just before last week's earnings release, the company surprised almost everyone by announcing that it will acquire Berry Petroleum (NYSE: BRY). Is the company trying to hide a poor performance behind the merger news? Let's take a better look at what happened during the past quarter and what the new Linn-plus-Berry company has to offer.
Building a reputation
Thanks to large price discrepancies for crude oil and natural gas in America right now, there aren't too many buyers out there. Linn has been one of the most notable exceptions to this trend. Tallying everything up, 2012 resulted in about $2.9 billion in acquisitions and joint ventures. A large chunk of that figure was from the $1 billion million the company spent buying Green River Basin assets from BP (BP 0.10%) back in June. Since its IPO in 2006, the company has spent more than $10 billion in acquisitions. So far, these asset buys have turned out well for the company. Linn achieved an 869% reserve replacement ratio in 2012 thanks to its acquisitions. That means the company has gained 869% more oil and gas on its reserves than what it produced in the year.
With such impressive post-acquisition results, it's easy to glance over the operational results of the company as well. If we don't include reserve gains from acquisitions, then the company still achieved a reserve replacement ration of 150%. This number can mean a couple of things. It could mean that some reserves have been promoted to proven because of increased commodity prices, or it could mean the company has done a commendable job of increasing its operational efficiency. Either way, it is a healthy sign that the company has been able to eke out more value from its assets.
The shopping spree continues
With this new purchase, Linn has added some needed liquids production to its portfolio. Berry is producing about 40,000 barrels of oil equivalent, 75% of which is actually oil. The combined portfolio of Linn and Berry brings Linn's total liquids production from 46% to 54%, making a once predominantly natural gas company into a diversified energy play. The new assets in the deal will increase the company's proved and probable reserves by 3.8 trillion cubic feet equivalent.
Linn will buy Berry for about $2.5 billion, but it will also incur all debts for the company, which makes for a total deal of about $4.3 billion. What makes the Berry acquisition unique, though, is the structure of the deal. Linn will be financing 100% of this transaction with equity, and with its dual structure of an MLP holding company and its operating arm, LinnCo (NASDAQ: LNCO), it was able to incur a tax-free exchange of shares.
With such a large acquisition coming on board, you might expect Linn to take a break from the M&A market for a while, but that may not be the case. When asked whether the company would hold off on any other potential buys in the near term, Linn CEO Mark Ellis said the company hasn't necessarily ruled out the idea of pursuing other deals, even while closing the Berry deal. Company management reiterated that they anticipate that $20 billion to $30 billion in assets will be available for purchase in the next 18 months, so don't be surprised if you see Linn in the headlines again soon.
What a Fool believes
With its MLP structure, Linn has a management team that focuses on achieving a distribution coverage ratio of about 1.2 for its operations. For 2012, the company ran itself a little thin of that metric, with this quarter coming in at about 1.07. This shouldn't affect the company's distributions for the time being, and Linn anticipates returning to the 1.2 level by late 2013. Once the Berry acquisition officially goes on the books, the boost in production revenue should help to bring that number back into sync.
This buy could be the biggest test of the company's reputation as an acquisition specialist. Much of the company's previous buys have been assets of a company, but this is a whole company. Linn management anticipates that they will leave much of the established system for Berry intact while the integration ramps up, and common expenditure plans will be established for 2014. The two companies have a couple of places where they both hold interests, most notably in the Permian Basin. Expect the Linn/Berry entity to try to optimize efforts in these areas.
The meteoric rise of Linn is reminiscent of another former big asset buyer: Chesapeake Energy. The problem with Chesapeake, though, is that its buying habit outpaced its production capacity and its debt load just became too cumbersome. Is Linn headed down the same path? It's probably a little too early to tell. But if you want to learn how the story continues for Chesapeake, check out our premium research report. It will give you an inside look at what's next for the company's turnaround. Simply click here now to access your copy, and as a bonus, you'll receive a full year of key updates and expert guidance as news continues to develop.
