02/28/12: Major Deal Should Fuel Distribution Growth

After the market closed on Feb. 27, 2012, Growth Portfolio holding Linn Energy LLC (NSDQ: LINE) announced an agreement to acquire wet-gas fields in Kansas’ Hugoton Basin from energy giant BP (LSE: BP, NYSE: BP) for $1.2 billion. Natural gas liquids (NGL) account for about 37 percent of output from these properties, with natural gas making up the remaining 63 percent.

Although natural gas prices remain depressed in North America, Linn Energy has purchased these properties at a price that makes the transaction immediately accretive to distributable cash flow (DCF). Moreover, the limited liability company disclosed that it has hedged 100 percent of the acreage’s expected natural gas production and 68 percent of its NGL output over the next five years. This move limits the firm’s exposure to unfavorable swings in commodity prices.

The deal is important for two reasons.

When Linn Energy has made major acquisitions in the past, the subsequent boost to DCF has prompted management to hike the distribution. The partnership last increased its quarterly payout in August 2011, from $0.66 per unit to $0.69 per unit. This latest deal is large enough that Linn Energy could accelerate the pace of distribution increases in 2012–a significant upside catalyst for the stock.

Second, the size of the transaction demonstrates Linn Energy’s ability to access capital at favorable rates. The firm will initially finance the deal by using excess capacity on its expanded revolving credit facility and will likely use the proceeds from a recent $700 million offering of new units and a $1.5 billion bond issue to pay down credit line. Linn Energy’s current bonds that mature in 2020 yield 6.6 percent, so we expect the latest bond sale to yield a similar cost of capital.

With ready access to the capital markets, Linn Energy was able to take advantage of BP’s need to raise capital to pay for damages related to the 2010 Macondo oil spill. This latest deal should enable Linn Energy LLC to increase its distribution; the stock rates a buy up to 40.

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