Is LINN Paying Too Much For Berry?

Is LINN Paying Too Much For Berry?

LinnCo and its sister LINN Energy raised the bid for Berry Petroleum on Monday. On first blush, the price seems like a knee jerk reaction just to get the deal done. The share ratio jumped 34% from 1.25 to 1.68 LNCO per BRY share. That represented a premium to where both were trading. BRY shares have been running at about 1.5 times LNCO for most of the trading period following the announcement as LNCO and LINE shares twisted in the wind.

The SEC informal inquiry severely hampered prospects for the deal. Combined with the apparent removal of that SEC hurdle, LINN Energy obviously hopes this raise gets the deal done. The question becomes, is LINN reaching and paying too much for Berry? We'd probably see units trade down if the deal fell through, and management is likely sensitive to that issue. But a 34% increase, and a premium to BRY's current PPS? That's a tough pill to swallow.

Until you do the math
The 34% premium to the original deal seems excessive, but it's more important to focus on the full cost of the deal rather than just that equity component. The original deal totaled $4.3 billion structured as LNCO equity and assumption of Berry debt. The adjustment of the ratio slides that up to $4.9 billion, which is really only a 14% increase over original terms. The slip in LNCO shares is the real culprit that's driving dilution here.

On a proved barrel basis, the deal goes from excellent to good for LINE and LNCO holders. Berry's 275 MMBOE (million barrels of oil equivalent) costs LINN $17.82 per barrel at the adjusted figure. That's up from $15.64 on the original terms, but on par with Linn's recent $525 million dollar Permian acquisition. That deal brought 30 MMBOE at $17.50 per proved barrel.

Gazing back through prior transactions, that $17 mark is a common price tag that LINN's accepted for oil-rich assets in the past. At times, LINN's even paid up for higher profile assets. Berry's recent operational success is another obvious reason for the reset. Production is up from early 2013's 39.5 MBOEd (thousand barrels of oil equivalent per day) to 41.7 MBOEd.

On a flowing barrel basis, the original deal worked out to $109,000 per barrel back in Q2. With the increase in production and compensation, the new terms work out to a pretty similar endpoint of $118,000 per flowing barrel. That's a modest 8% increase on a production basis. These numbers are also in line with recent purchases. That recent Permian buy priced at $109,000 per flowing barrel for comparison.

Given Berry's oil-rich asset base and how large a game changer this is, the price seems fair. If anything, the original transaction price was low for Berry holders, jeopardizing its closure. The reset is a nice carrot for BRY that is still a good deal from LINN's perspective.

All I want for Christmas
The timing of closure was another item of interest on LINN's Q3 call. The deal termination date was extended to January 31st, with an expectation that the deal could get done as early as mid-December. It sounds like a more likely outcome is probably the end of December. Yet another S-4 will need to go through. Happily, changes are minimal. The date is pushed out and the ratio reset. All other terms, including the walk away penalties for both parties remain in force, subject to the new termination date.

Another unfortunate disclosure was that the SEC informal oversight remains. LINN's previous statement regarding SEC closure was limited to the SEC's review of the S-4 registration. Review of non-GAAP metrics is ongoing and LINN continues to cooperate.

Closing on Berry would be a nice Christmas present for all concerned. Analysts were eager to pry out details regarding the possibility of a distribution hike following the deal. However, little was disclosed beyond management's insistence that the deal will be immediately accretive. We'll just have to wait and see.

A peek into the future
There were some interesting comments regarding LINN's future capex spend. While LINN will need time to assess its magnitude, it seems that management actually has a head start on developing its drilling program's overall direction once Berry is folded in. Granite Wash spends should remain conservative as LINN focuses on its oil-rich portfolio in preference to other NGL-rich mid-con assets.

With the Permian purchases, LINN's horizontal Permian potential—barely scratched at this point—is roughly doubled. Berry's California assets are exceptionally slow decline and the Uinta has growth potential. With a larger list of black oil options, LINN can afford to be choosy, if and when the deal goes through. That should ease the NGL crimp as the NewCo moves its liquids mix away from NGLs toward black oil.

In turn, Berry gains much better access to capital and realizes the value of its assets at a strong premium to where it was trading before LINN lined up as a suitor. And that comes in a flagging price environment for oil. The combined company has good balance in oil/gas mix and has a long list of drilling options in a wide variety of plays. The ratio reset was a good move for all parties and should get this deal done. Hopefully, Christmas will be coming early for LINN holders this year.

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