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Linn Energy Amends Berry Petroleum Merger as Accounting Woes Ease

Updated from 9:24 a.m. ET to include opening share prices and comment from MLV & Co.

NEW YORK
(TheStreet) -- Linn Energy (LINE) has amended the terms of its proposed acquisition of Berry Petroleum (BRY), as the upstream oil and gas master limited partnership (MLP) continues to press for a deal and resolve accounting concerns that have weighed on the company's share price in recent months.

Linn Energy, through its acquisition unit LinnCo (LNCO), will offer 1.68 shares for each Berry Petroleum share, in a transaction that is now valued at $4.9 billion when including debt. The Houston-based driller previously offered Berry Petroleum investors 1.25 shares of LinnCo for each of their shares.

The revised merger proposal will increase the price of Linn's acquisition by roughly $600 million, according to Friday closing share prices.

Linn Energy shares were rising nearly 4% to $32.05 in Monday afternoon trading. Shares in Linn Energy surged by over 11% on Friday after it said in a filing that the Securities and Exchange Commission had resolved its comments on the company's accounting disclosures.

"As of the date hereof, there are no outstanding or unresolved comments in any comment letters of the staff of the SEC received by the Company relating to the Company SEC Documents," Linn Energy said in its filing.

In July, the company disclosed it was subject to an informal SEC review into its accounting disclosure.

Friday's note that the SEC has no outstanding comments on the company's accounting disclosures may help Linn Energy close its long-awaited merger of Berry Petroleum.

As part of Linn Energy's increased share exchange for Berry Petroleum, both parties agreed to extend a deadline on the merger transaction through Jan. 31, 2014. Linn's initial bid, made in early 2013, had set an Oct. 31, 2013 deadline.

Michael Peterson, a managing director and senior energy analyst at MLV & Co., said in a telephone interview that while the SEC has not yet declared Linn Energy's S-4 effective, it was "very likely" to do so.

Linn Energy will file an amended merger proposal to the SEC to reflect its increased share exchange offer, the seventh amendment since a deal was first announced. The boards of both Linn Energy and Berry Petroleum have approved Monday's revised offer.

"The boards and management teams of LINN and Berry remain committed to completing this merger. We continue to believe that, upon completion, this transaction will create tremendous value for LINN Energy, LinnCo and Berry investors," Mark E. Ellis, Linn Energy's CEO and Robert F. Heinemann, Berry Petroleum's CEO said in a joint statement.

Linn Energy and Berry Petroleum have set a record date of Nov. 14, 2013 on the amended transaction and anticipate scheduling shareholder meetings to vote on the all-stock deal by mid-December.

Peterson, the MLV analyst, said that Linn's revised offer may be a structural positive for Linn Energy and vindicate its accounting. The deal, however, could also prove to be expensive.

"This is a 34% premium to the deal that was previously announced and I don't know if anyone that thought the deal was accretive by 34%." Peterson said.

Monday's amended deal indicates that uncertainty over Linn Energy's finances and its poorly performing share price might have caused it to increase the exchange ratio. Strong recent operating results at Berry Petroleum might have given impetus for a rising deal price.

In late October, Berry Petroleum reported third quarter adjusted earnings per share of 95 cents, ahead of consensus of 89 cents as a result of higher oil volumes and lower costs, according to Sterne Agee analyst Tim Rezvan.

"Linn Energy will have to significantly sweeten terms to get Berry shareholders to ultimately approve the deal, especially in light of this morning's strong [third quarter] operating results," Rezvan wrote in an Oct. 23 client note.

"Since initially engaging with Berry, their operations have consistently outperformed expectations, which is evidenced by their recent third quarter 2013 results," Linn Energy CEO Mark Ellis said in a Monday statement.

Linn Energy's operating results also showed improved performance in the third quarter. The company's third-quarter earnings met guidance after two successive earnings misses and beat Wall Street forecasts.

The company reported third-quarter adjusted EBITDA of $388 million, according to calculations from Wells Fargo analysts, above consensus of $370 million, on slightly higher energy production, higher commodity prices, and lower operating expenses.

"We reiterate our Buy rating and remain positive on Linn's ability to execute on its strategy of growth via acquisition of low-decline mature assets with a predictable cash flow profile, and, in the meantime, believe the distribution provides an attractive yield," Goldman Sachs analysts wrote in reaction to the firm's earnings.

Linn's third-quarter earnings were also the first since the company amended its accounting disclosures, on recommendations from the SEC.

In September, the company said it re-defined some non-GAAP financial metrics such as maintenance capital expenditure and distributable cash flow (DCF). However, those changing definitions didn't impacted Linn Energy's underlying financial picture.

Instead of "maintenance capital expenditure" Linn Energy now uses the term "discretionary reductions for a portion of oil and natural gas development costs." This metric includes estimated drilling and development costs to convert the company's energy reserves to producing status. The metric doesn't include the historical cost of the company's acquired oil and gas properties.

"We believe production and excess net cash provided by operating activities represent the new key headline evaluation metrics provided by the company. Fundamentally, LINE's cash flows have not changed," Wells Fargo analyst Praneeth Satish said in an Oct. 29, client note.

Linn Energy's accounting practices and the non-GAAP metrics that drive its dividend came under scrutiny in recent months from Barron's and independent research firm Hedgeye Risk Management.

Both Barron's and Hedgeye argued Linn's use non-GAAP accounting figures overstate the cash flow it can pay out to shareholders and under-report the expenses tied to its hedging practices and capital expenditure. Hedgeye also calculated that Linn Energy's cost of replacing its oil and gas production was about $25 per barrel of oil equivalent (BoE), while the company's financial results and analyst calculations generally indicate replacement costs of about $15 per BoE.

If Linn Energy and Berry complete their merger, it would likely refute many of the concerns raised by Barron's and Hedgeye.

The SEC's completion of commentary on Linn Energy's accounting disclosures also appears to undermine analysis that the firm has not been upfront with its investors.

"One of most expensive E&Ps in US. With zero organic growth and highly aggressive accounting. Who cares I guess," Kevin Kaiser, the Hedgeye analyt covering Linn Energy said on Twitter.

Jim Cramer, founder of TheStreet and contributor to Real Money Pro, currently owns Linn Energy shares in his Action Alerts PLUS charitable trust, along with co-portfolio manager Stephanie Link. Cramer has supported Linn Energy and invited CEO Ellis on his CNBC show Mad Money to rebut Barron's analysis.

On July 2, Link said in a Real Money Pro post that the charitable trust would sell 1,400 Linn Energy shares at $29 apiece given the SEC's informal review.

Action Alerts PLUS continued to own 1,000 Linn Energy shares after its stake sale, roughly 1.2% of the overall portfolio. In a Monday post Action Alerts said "[we] added meaningfully to this position on Friday following the SEC news and will add another 500 shares, which have a bid/ask of $32.20/$32.30."

After trimming its holding of Honeywell (HON) shares to increase its Linn Energy stake, Action Alerts will
own 2,000 shares of Linn Energy, or 2% of the portfolio.

-- Written by Antoine Gara in New York

Follow @antoinegara

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