Did LINN Energy Overpay for Devon Energy's Assets?

Comparing this recent LINN Energy deal to others it has made over the past two years puts this Devon Energy acquisition in prospective.

Tyler Crowe
Tyler Crowe
Jul 11, 2014 at 10:42AM
Energy, Materials, and Utilities

Source: LINN Energy Media Relations

It's not exactly easy for individual investors to look at an asset purchase and determine if it is a good deal or not. So we end up managements word for face value, which is obviously going to be positive. For LINN Energy (NASDAQOTH:LINEQ) (UNKNOWN:LNCO.DL), we look for how those assets fit into its master limited partnership structure, but sometimes we overlook whether the company overpaid or not for those assets. Fortunately for us, LINN Energy has been such an active buyer of assets that we have several other deals we can compare it to. So let's do a side-by-side comparison of its recent deal with Devon Energy (NYSE:DVN) and some of its most recent deals and see how this one stacks up.

Lining up the culprits
In the past two years, LINN has made four major acquisitions greater than $1 billion: This recent one with Devon, the merger with Berry Petroleum, and two deals with BP (NYSE:BP) for acreage in the Jonah field of Wyoming and its Hugoton gas assets. Here's how each of these deals looked like at the time of the acquisition:

Deal Proved Reserves (boe) Production (boe/d) Production Mix % of Acreage Producing Decline Rate  Price
Devon Energy 234-270 million 49,500 80% gas 75% 14% $2.3 billion
Berry Petroleum 275 million 40,000 80% oil 56% 15% $4.9 billion
BP Jonah 135 million 26,000 73% gas/ 27% NGL 56% 14% $1.025 billion
BP Hugoton 131 million 19,800 63% gas/37% NGL 81% 7% $1.2 billion

Source: Company Investor Presentations and press releases

Based on this information alone, we can get a general feel for these deals. Obviously assets producing gas are less valuable than those producing oil and assets that require more capital -- those with a lower percentage of acreage producing -- will sell at a slight discount. One thing that is missing, though, is that as part of the BP Hugoton gas purchase, LINN also acquired BPs gas processing facilities in the region. That is part of the reason why it looks like LINN spent a little more for that purchase than for the Jonah field purchase.

But this only gives us a general comparison, so let's do a more apples-to-apples comparison by comparing these deals on price paid per proved reserve, per producing barrel, and on profitability. While the first two are pretty self explanatory, we'll measure profitability by the EBITDA multiple for each of these deals. This is the price LINN paid divided by the amount in EBITDA that particular asset was producing at the time of the sale. Another way of thinking about it is the EBITDA multiple is how many years that it will take before the asset generates enough in profitability to cover the original purchase price.

Deal Price per Barrel of Proved Reserves ($/boe) Price Per Flowing Barrel of Production ($/boe/d) EBITDA multiple
Devon Energy $8.51-$9.83 $46,940 6.5x
Berry Petroleum $21.30 $122,500 14x
BP Jonah $7.59 $39,420 6.4x
BP Hugoton $9.16 $60,600 7.5x

Source: Company Investor Presentations and press releases, authors calculations

If we look at all of these deals through the same lens, it looks as though this new purchase was one of the best deals the company has signed. LINNs purchase of the Jonah field was valued for a little bit lower on just about every metric, but only 56% of that field was producing versus 75% for the Devon deal, so it will take less development capital to finish work in that field. Also, LINN estimates that about 3 trillion cubic feet equivalent can be extracted from these Devon assets, which would mean that the price of reserves could be as low as $4.25 per barrel equivalent.

Another thing that really stands out here is the price it paid for Berry Petroleum. It would appear, based on these metrics, that LINN overpaid by quite a large amount to make that merger happen. In reality, though, that is the stark difference in the price paid for a barrel of produced oil versus produced natural gas or NGLs. Deals involving oil producing assets in places like the Bakken or Eagle Ford have sold for prices in the $115,00-$135,000 per flowing barrel equivalent. 

What a Fool believes
You can pretty much rest assured that this is not the last deal that LINN makes. One of the reasons that it set up LinnCo was to facilitate these kinds of deals in the first place. So using this data will help you get a better feel for how much LINN pays for assets in the future. Based on this information, it appears that this deal was well worth doing and the company was justifying the sale of its Granite Wash assets to make it happen. Considering the level of profitability this deal brings, it wouldn't be too surprising to see LINN raise its distribution because of it.