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Saturday, 26 July 2014

Mastering M&A

A $4.3 bln oil deal parlays financial engineering

A $4.3 billion oil deal parlays the financial engineering of an already financially engineered corner of the industry. Linn Energy’s $4.3 billion acquisition of Berry Petroleum marks the first time an oil-producing master limited partnership has swallowed a whole exploration company. The bold move leans on the tax advantages of such structures and raises their risk profile.

The $300 billion MLP sector, which is allowed to pass profit through to investors before it is taxed, has its foundations in pipeline companies whose steady fees are broadly impervious to the wild swings in commodity prices. In recent years, MLPs have been expanding into new and more volatile areas, including exploration and production. Linn Energy is the largest among them with a $7.5 billion market value.

Last year, the partnership raised the risk stakes. It set up LinnCo - a shell company - to create a currency for billions of dollars of deals a year. The idea is to keep adding returns from older wells to the income stream. Tax advantages partly explain how Linn can pay just a 20 percent premium for Berry, about half the average fetched by exploration companies last year, according to Thomson Reuters data.

The wheeling and dealing involved is head-spinning. LinnCo will issue new shares to fund the deal. Then, Berry will be converted into a limited liability company. Following that, its assets will be swapped for units in the MLP. All of this will allow Linn Energy to own Berry’s reserves and fields without any immediate payment of tax.

It’s a long way from oil partnerships of yore. The sub-sector in which Linn Energy operates, the scale it is pursuing and the way in which it is going about it shouldn’t be confused with a typical MLP. Companies like Linn hedge considerably to mitigate gyrations in oil prices, but hedges don’t always work perfectly and some exposure will always remain anyway.

It’s why investors in Linn Energy demand an 8 percent yield compared to just 4.7 percent for Enterprise Products Partners, a $50 billion pipeline MLP. The gap should arguably be larger, given Linn and its peers collectively pay 8.6 percent. Any narrowing would be a red flag that the risks are outrunning the possible rewards.

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Oil and gas producer Linn Energy, a master limited partnership, said on Feb. 21 it would buy Berry Petroleum for $2.5 billion in stock. Including debt, the deal is valued at $4.3 billion.

Berry shareholders will receive 1.25 shares of LinnCo, a company set up by Linn Energy to raise money for acquisitions and other purposes. LinnCo, which went public in October, only owns Linn units and has no assets or operations.

Berry shareholders will get an equivalent of $46.24 per share based on LinnCo stock’s closing price of $36.99 on Feb. 20. This is a 19.8 percent premium to Berry’s closing price of $38.59.

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