LINN ups the ratio and BRY is still committed to the deal, despite LINN's ongoing SEC inquiry. In our view, the deal changes little fundamentally, but will likely serve to improve sentiment and confidence in LINE / LNCO in the near-term, particularly around its C-Corp E&P roll-up strategy. Short LINE / LNCO remains a Hedgeye Best Idea.
LINN / BRY Revises Merger Terms......
- Stock-for-stock deal ratio increased 35% from 1.25x LNCO shares to 1.68x LNCO shares (incremental ~24MM LINE units / LNCO shares)
- No cash component
- End date moved from 10/31/13 to 1/31/14
- Unit / Shareholders expected to vote on transaction in mid-December
- Conference call tomorrow, 11/5 at 11am EST, to discuss merger and 3Q13 results
Understated Maintenance CapEx = “Accretion”……LINN will offer BRY 1.68x LNCO shares per BRY share, a 35% increase in the ratio from the prior 1.25x. That’s an additional 24MM LINE units (now 94MM new units) to pay a distribution to (currently $2.90/unit/year). LINN states in the press release that, “The transaction is expected to be accretive to LINN’s cash available for distribution,” however, we believe that LINN is materially understating BRY’s maintenance CapEx (last guided to ~$240MM per year), which is the source of all of the alleged “accretion.”
BRY’s turn to focusing its capital exclusively on oil production has come at a high cost. In 2012, BRY’s organic proved developed (PD) F&D cost was $41.38/boe (17.9MM boes added at a cost of $741MM), up from $24.56/boe in 2011. LINN’s guidance for BRY maintenance CapEx of $240MM per year implies an F&D cost ~$15.00/boe if we assume exit rate 2013 production of 42,500 boe/d; in our view, $15.00/boe is inconsistent with BRY’s actual capital intensity, as we show in the tables below. Assuming an F&D cost of $30 - $40/boe, BRY CapEx to keep production and reserves flat in 2014 would be $465MM - $621MM, resulting in LINE distribution per unit dilution of 9 – 25%.
Change in LINE-to-LNCO Tax Liability Payment……LINN amended the LINE / LNCO “Contribution Agreement” such that LINE will no longer pay LNCO a $6MM distribution in 2013, 2014, and 2015 to compensate LNCO for assumed tax liabilities: “Pursuant to the Contribution Agreement Amendment, LINN no longer has an obligation to pay LinnCo a special distribution for tax liabilities fixed at $6 million per year for 2013, 2014 and 2015 and instead, LINN and LinnCo agree to work in good faith at the end of 2013, 2014 and 2015 to determine whether and in what amounts LINN should make tax liability distributions to LinnCo to reasonably compensate LinnCo for the actual increase in tax liability to LinnCo, if any, resulting from the allocation of amortization, depletion, depreciation and other cost recovery deductions using the “remedial allocation method” pursuant to Treasury Regulations Section 1.704-3(d), with respect to the assets acquired in the Contribution” (11/4/13 Form 8-K). LINN expects LNCO’s cash tax liability to be “approximately $0.00, $0.01 and $0.07 per share for 2013, 2014 and 2015.”