Source: Linn Energy Media Relations
Staking two MLPs up against one another
LINN and Vanguard are both exploration and production companies that are structured as master limited partnerships. To make this unique corporate structure work in the E&P space, they both need to be exceptional at three things: acquiring mature oil and gas properties on the cheap that will have long production lives; squeezing every last molecule of oil and gas out of these assets in a cost-effective manner; and ensuring stable cash flow by aggressively hedging the price of the oil and gas they produce.
LINN and Vanguard have proven that they can be extremely efficient operators and put very effective hedging strategies in place to ensure predictable cash flow. We as investors are able to measure these two items. LINN has shown repeatedly that it is an extremely efficient operator. In 2013 alone it was able to bring down drilling and completion costs by more than 11% in both the Granite Wash and the Permian Basin, two of the company's largest production regions. Vanguard, on the other hand, does very little actual drilling, which keeps its operational costs even lower. In 2012, Vanguard's capital expenditures to adjusted EBITDA was only 22% compared to the MLP average of 66%.
The major differences between these two companies are their size and their appetite for acquisitions. Since 2010, LINN has spent $11.3 billion on new assets and even spun off its operational arm LinnCo (NASDAQ: LNCO) to allow for larger acquisitions like the recent merger with Berry Petroleum. Vanguard, on the other hand, is much more conservative with its acquisitions. Over that same time frame, Vanguard has only spent $2.6 billion on acquisitions.
One element that is extremely difficult to compare between MLPs is how effective management is at negotiating a price for acquisitions, because normally they are in different regions or they are for different amounts of acreage or the amount of developed and producing wells don't match up well. Fortunately, we now have a way to do a pretty close apples to apples comparison.
Last week, Vanguard announced it was purchasing 14,000 net acres in the Pinedale natural gas field from Anadarko Petroleum (APC +0.00%). These assets have reserves of 847 billion cubic feet equivalent of natural gas net to Vanguard and produce about 113 million cubic feet equivalent per day; about 80% of it is dry natural gas. LINN made a similar purchase in 2012, acquiring a working interest in several wells in the Pinedale field from BP (BP +1.00%) that amounted to about 730 billion cubic feet equivalent net to LINN and 80 million cubic feet equivalent per day of prodiuction.
Both deals had relatively similar levels of existing production, production mix, and were very close in terms of location. The difference is that Vanguard paid $581 million for its recent acquisition, while Linn Energy paid $1 billion.
There are some differences in these two purchases worth noting. A large portion of the assets Vanguard purchased are unproven reserves, and it will only have a 10% nonoperating interest in these wells. LINN, however, has a 55% operator stake in its Pinedale acreage. When you tally these things up, though, it is awfully hard to justify a difference in price of over $400 million.
What a Fool believes
The sticker prices for the LINN and Vanguard purchases in the Pinedale mean one of two things: Either LINN Energy didn't get as good of a deal on its Pinedale acreage as previously thought, or Vanguard got an absolute steal this time around.
If you look over the LINN deal, the price it paid doesn't seem completely unreasonable for what it got. It received wells that have one-year decline rates of only 15%, a great number for a tight gas formation. The price averages out to $1.36 per thousand cubic feet of proven reserves, but at the time LINN estimated that it could boost proven reserves by 64% to 1.2 trillion cubic feet equivalent, which would mean the company would pay $0.83 per thousand cubic feet of extractable resources. Just to give comparison, the top driller in the region, Ultra Petroleum (UPL +0.00%), has lease operating expenses of $0.37 per thousand cubic feet of reserves. Vanguard, on the other hand, was able to pick up its recent acreage at a cost of $0.63 per thousand cubic feet of reserves.
Probably the best summary of these acquisitions is that Vanguard got the better deal, but LINN's wasn't a bad buy if it can truly get the amount of gas it estimates. If that fails to happen, though, then it is likely the company paid a bit more than it should have for these assets, especially at a time when natural gas prices were extremely depressed.
Overall, these deals don't really change the investment thesis for either LINN or Vanguard. MLPs have to buy mature assets to grow, and not every deal they make will be amazing. Still, the idea that LINN paid a $0.73 premium on proved reserves in comparison to Vanguard does make us reconsider the company's stellar acquisition reputation.
