Sunday, February 23, 2014

Linn Energy Heads Up On Berry Merger Benefits

 This article was originally published by TheStreet and also appeared on Yahoo! Finance
By Sarfaraz A. Khan. Research Assistant: Gohar Yousuf February 23, 2014
NEW YORK (TheStreet) -- The units of the upstream MLP Linn Energy (LINE_) have struggled last year, dropping by more than 12% in 2013. However, some new developments in 2014 have paved the way for recovery and the company's shares are up nearly 6% since January. The business is now looking much more attractive following the completion of its merger with Berry Petroleum, which also brings to an end all the speculation related to the massive transaction.
Following the merger, Linn has considerably improved its asset portfolio and is eyeing an uptake in production and revenue, despite the severe weather conditions. I believe the shares will go higher on the back of higher output and solid cash flows.
Linn Energy is currently trading at around $32.60 while its C-Corp, LinnCo (LNCO_) is hovering at $31.60. At these price levels, both offer juicy yields of almost 9%. LinnCo's price has historically been around 7% above Linn Energy. Although both are attractive at the moment, the C-Corporation is now cheaper and will likely return to its normal levels in the near future, which makes it a better bargain.

The under-performance from Linn Energy's units can be partly attributed to criticism from short sellers (such as here), which, I believe, was largely without merit. Nonetheless, the shorts fueled speculation. In the meantime, the Securities and Exchange Commission launched an informal investigation into the merger. Moreover, the falling prices of natural gas liquids and the disappointing results from the business's wells at the Hogshooter play made things even more difficult for the business.
As a result, Linn Energy's units, despite decent growth prospects and attractive yield, have largely remained under pressure throughout 2013.
However, earlier in mid-December, the business completed the much awaited $4.9 billion merger with Berry Petroleum. To facilitate the deal, Linn created its C-Corporation, LinnCo, which acquired all outstanding shares of Berry Petroleum. Besides this deal, no other upstream master limited partnerships or LLC has ever acquired a C-Corporation.
Through this acquisition, Linn Energy significantly improved the size and quality of its asset portfolio. The merger is also in line with the company's long term strategy to become one of the leading independent energy firms of North America with assets that have a long life and low decline rate. Following the merger (on pro-forma basis), Linn became the 12th biggest American independent oil and gas company, ahead of Range Resources (RRC_) and behindContinental Resources (CLR_).
A large part of the criticism on Linn Energy has been about the company's focus on mature wells that have long passed their peak production days. However, this does not mean that mature assets are something from which oil companies should stay away. On the contrary, a significant portion of U.S. oil production comes from older wells. Moreover, the two big boys of this industry,Exxon Mobil (XOM_) and Chevron  (CVX_), have a significant portion of mature wells in their upstream portfolios.
Berry Petroleum's reserves, which have been acquired by Linn, are also mature and attractive with a decline rate of 15% and reserves life of more than 18 years. Besides these, Berry also has 630 million barrels of probable and possible reserves. Moreover, the reserves will also considerably increase Linn's exposure towards liquids as Berry Petroleum's assets are mostly (75%) liquids. In short, Linn Energy can now boast of 1.1 billion barrels of oil equivalent of proven reserves that are 54% liquids.
Linn Energy has had ample time to prepare for the massive merger, therefore, I believe that the two firms will not have any major integration problems.
As for the problems at Hogshooter play, Linn Energy has now shifted its focus from the Texas side of the play that delivered the poor results, to Oklahoma side of the play that looks much more promising.
Moreover, the two companies now have attractive positions at the Permian Basin. Following the merger, Linn has more than 160,000 net acres in the region, with 160 million barrels of proven reserves that are 80% liquids. The businesses will have ample opportunities for horizontal drilling in the region, which can give a significant boost to cash flows in the coming quarters.
Meanwhile, despite the severe weather conditions at the Permian and Mid-Continent region, Linn Energy is still expecting output of 840 to 860 million cubic feet equivalent per day (MMcfed), showing an improvement from 823MMcfed in the previous quarter and 800MMcfed in the fourth quarter of 2012.
On the other hand, some of the other operators, such as Pioneer Natural Resources(PXD_) were forced to cut their production and drilling activities in the region, which affected Pioneer's quarterly production.
Linn Energy has suffered due to the weakness in energy prices. The firm, however, is now expecting improvements due to the positive trends in natural gas liquid prices.
Linn's new guidance indicates its cash position has already improved. The business is now expecting cash flow to be 5% to 10% above its distribution in the fourth quarter, as opposed to its prior estimate of 0% above the distribution. This can be attributed to the improvement in natural gas liquid prices and the firm's effective control over its operating expenses. Further improvement in prices will add to the firm's solid cash flows.