Monday, December 16 represented the day many LINN Energy (LINE +0.00%) investors were waiting for. The much-anticipated vote to acquire Berry Petroleum (NYSE: BRY) passed, and the acquisition officially closed immediately after. Interestingly, LINN units did not bounce as some might expect, given that the market usually loves certainty. And, shares of LINN's financial holding entity, LinnCo (NASDAQ: LNCO), which were used to finance the deal, have actually sold off since Monday's vote.
Despite the market's tepid reaction, investors should have full confidence in the company's future. By acquiring Berry, LINN has fulfilled its biggest strategic initiatives: primarily, to find extremely high-quality assets for production of oil and gas. As a result, LINN has many profitable years ahead for investors.
Why Berry's assets are a perfect fit
LINN's management team maintains a fairly simple strategic view of its business: to acquire and develop high-quality properties for production of oil and gas. Fulfilling those objectives is how an exploration and production company grows and funds its massive distribution, and it's something the company takes very seriously. LINN's management team has a sterling track record of making deals that are directly beneficial to LINN's unit holders, and the Berry deal is no exception.
Berry's assets fulfill LINN's priority of finding high-quality properties. Berry's assets hold a depletion rate of just 15%, and a reserve life greater than 18 years. In addition, Berry's portfolio will solve a separate desire for LINN, which is to increase its liquids exposure. That's because Berry's reserves are 75% liquids.
Put simply, upon integrating Berry, LINN will be a force to be reckoned with among exploration and production MLPs. LINN's overall production will increase by 30%, and the company will now be the fifth-largest producer in California.
Further benefits of the Berry Petroleum acquisition
Not only does Berry offer high-quality assets that LINN craves, but the deal also has the potential for significant synergies. Investors who fear LINN overpaid for Berry should be at least somewhat comforted by the fact that management will realize considerable cost cuts, since Berry will perfectly complement LINN's existing operations.
LINN's significantly increased size and scale will lower financing costs and provide greater access to capital. In addition, LINN's debt metrics are expected to improve, as the transaction provides for additional liquidity.
It's reasonable to wonder why units of LINN and shares of LinnCo reacted poorly to the news. After all, the pending Berry acquisition was the biggest concern for investors heading into the new year. One possible solution may be that the market thinks LINN overpaid for Berry. It's true that LINN had to increase its original offer, from 1.25 shares of LinnCo to 1.68 shares.
In all, LINN paid a 45% premium to Berry's closing price the day after the deal was first announced. Despite a hefty premium paid, it's abundantly clear that LINN will reap huge rewards from acquiring Berry. The expected benefits far outweigh the negatives.
Don't forget the distribution
Not only does the Berry acquisition make great sense from an operational standpoint, but LINN and LinnCo investors are likely to see immediate benefits. LINN's hefty 10% distribution will be well-covered by distributable cash flow. And, management has long maintained its intention to increase its payout to $3.08 per unit of LINN and share of LinnCo. This has not happened yet, but it's an exciting possibility that could materialize once the integration of Berry is under way.
As a result, investors shouldn't be at all concerned with the market's lackluster response to the closing of the Berry acquisition. LINN's production will increase substantially, its liquids exposure is enhanced, and Berry's portfolio of long-lived assets with low depletion rates fits perfectly with LINN's upstream exploration and production business model.
