The recently announced acquisition by LINN Energy (NASDAQOTH:LINEQ) of Devon Energy's (NYSE:DVN) non-core U.S. assets has met mixed reviews. Wells Fargo analyst David Tameron thumbed his nose at the deal, while Raymond James analysts cheered the deal. LINE units and LinnCo (UNKNOWN:LNCO.DL) shares initially popped on the news, eventually plateauing. With analysts on both sides of the aisle, how can individual investors judge the deal for themselves?
Look to the past
For acquire-and-exploit companies like LINN Energy, reserve costs on acquisition are critical. Reserves are inventory, and inventory control is the name of the game. The easiest way to assess the deal is simply to compare it to prior deals. Comparison shopping can tell you a lot fairly quickly.
Barron's -- LINN Energy's perma-bear -- reported recently that Wells Fargo's Tameron feels LINN Energy overpaid with a $2.3 billion pre-tax price tag based on the Street's lower expectations, highlighting a few lines of a short note:
Not surprised the deal beat our $1.1B estimate which we viewed as conservative, but based on recent conversations with investors, proceeds also above high-end of expectation range (we think Street was modeling $1.2$-1.4B).
Tameron believes Devon got the better of LINN on the deal. Even if that's true, it's still a decent buy. The transaction is actually quite similar to Devon's prior sale of its Canadian conventional assets to Canadian Natural Resources back in February. That deal -- also heavy in natural gas -- went off at virtually identical metrics: 7 times 2013 EBITDA and $1.75 per mcfe of reserves. The present LINN Energy deal prices at a slightly lower 6.6 times 2013 EBITDA and $1.77 per mcfe of reserves.
The deal also compares reasonably with LINN Energy's two large BP transactions of 2012. The Hugoton purchase from BP cost LINN Energy $1.60 per mcfe of proved reserves, while the Green River BP assets priced at a bargain-basement $1.41 per mcfe. While noticeably cheaper, both transactions did occur in the darkest days for gas producers. The Hugoton purchase came in March of 2012, followed shortly by the Green River transaction in July. Henry hub spot prices bottomed at $1.86 per mcf in April of 2012, recovering only slightly very late in the year.
In light of the current $4.50 Henry Hub spot price, a 25% premium on the Green River acquisition seems defensible. Gas prices are up substantially, and BP was a very motivated seller as it raised cash to pay off its Macondo liabilities. Low commodity pricing and a motivated seller necessarily led to excellent deals on both BP buys. To me, the current deal looks reasonable based on these comps as well.
Three-way trades are always complex
They can also be pricey. It's important to note that this is not a normal acquisition. It's actually the front half of a 1031 "like-kind" exchange. A 1031 sale allows tax deferral of proceeds from the sale of an asset if the transaction is coupled to the acquisition of a similar asset. While it's challenging to line up partners for a transaction like this, dollars saved from the tax man sweeten the deal.
This is the same kind of swap that was just done with ExxonMobil (NYSE: XOM) in the Permian, but it will be done in two pieces. The transaction will eventually draw in a third party, with LINN Energy's Granite Wash acreage sold later to cover the cost of these Devon assets.
Three-way trades are necessarily complicated. While contract details remain unknown, it seems likely that contingencies exist allowing LINN energy to exit the deal should a Granite Wash sale not close in time to qualify for 1031 treatment. That uncertainty surely bears a cost. You can't draw up a contingent offer and then low-ball the seller. Flexibility always comes at a price, and that can't be ignored when evaluating the deal. A slight premium for that risk should be expected.
Waiting on an answer?
To me, the price paid here seems fair. It's in line with Canadian Natural Resources' previous Devon transaction, and even in the ballpark of LINN Energy's favorable BP transactions of 2012. The slightly higher premium to these latter deals seems justifiable given currently higher commodity prices and the added risk of a probable 1031 contingency. The deal should also improve the decline rate, reduce capital expense, and boost DCF. These are all good things.
Still, I'm still not sure we have enough information to fully evaluate the deal. The price seems fine, but no one knows yet what the back half of this 1031 exchange will look like. The Granite Wash is a significant operating region for LINN Energy, providing considerable production. Until we see the scope of the divestiture and its proceeds, it seems wise to reserve judgment. That's the real price tag for this deal: LINN's Granite Wash acreage. For now, investors need to wait and see how that Granite Wash sale proceeds before jumping to conclusions.