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Trend reverses as conventional assets dominate

Contrary to many deals playing out in the marketplace these days, the two largest deals of the 30-day period from mid-February to mid-March were not focused on unconventional resources.

In the largest deal, El Paso's E&P division, on the market since Kinder Morgan Inc. announced its $38 billion takeover of the company in October, found its buyer. In late February, Apollo Global Management and Riverstone Holdings agreed to acquire the division for $7.15 billion.

While one of the largest energy deals in the timeframe, the offer doesn't generate the same value implied by the EBITDA multiple in the Kinder Morgan/El Paso deal, had the E&P division received the same premium, noted Evaluate Energy analyst Eoin Coyne, whose firm had previously predicted the company fetching $8 billion. He points out that El Paso's production is 85% US gas, and therefore, exposed to the low natural gas prices.

El Paso holds nearly 3.3 million acres across the US, but US shale plays, the main driver of M&A activity over the past three years, hold only a small piece of the portfolio. As per El Paso's 2011 10-K, Apollo and Riverstone will receive 4tcf of resources at a cost of $10.72 per boe as part of the deal.

Another large deal consisting of more conventional assets involves LINN Energy LLC and BP America Production Co. In late February, LINN signed a definitive purchase agreement to acquire Kansas Hugoton Basin properties from BP for $1.2 billion. The company anticipates the acquisition will be financed with proceeds from borrowings under its revolving credit facility.

"This acquisition marks our entry into the largest conventional natural gas field in the US, and it is an excellent fit for our business strategy," said Mark E. Ellis, LINN's chairman, president, and CEO. "This impactful transaction has a low decline rate of 7% and is expected to provide 110 million cubic feet equivalent of liquids-rich production that is 37% NGLs. This acquisition should be immediately accretive to distributable cash flow per unit and is expected to provide a very steady stream of cash flow with little requirement for capital investment. We also fully hedged for five years 100% of natural gas production and 68% of NGL production, utilizing natural gas puts," he said.

Like the El Paso deal mentioned previously, the LINN/BP deal is gas-heavy. In this case, however, the pain of current US gas prices is cushioned as 37% of the reserves are composed of natural gas liquids. In addition, the reserves are "highly developed at 81%, are 98% operated and the financing that LINN Energy agreed upon immediately following the purchase was at a competitive rate of 6.25% making this acquisition fairly safe if not spectacular," Coyne noted.

For LINN, the deal marks the second largest in the company's history (following its $2 billion asset acquisition from Dominion Resources in 2007). For BP, the deal makes a small dent in its plan to sell mature assets to focus on higher growth opportunities and help pay the $37
billion charge resulting from the Deepwater Horizon explosion.

In another February deal, Whitecap Resources acquired Midway Energy for C$550 million. The deal represents the fifth for Whitecap since its inception as part of a reverse takeover of Spitfire Energy in June 2010. The oil-weighted deals in West Central Alberta and South East Saskatchewan, worth close to $1 billion, have been financed via $500 million of equity transfers and $350 million of placings.

In the past year shares of Whitecap increased 37%, but fell 6% the day the Midway deal was announced. Metrics for the Midway deal are high, even after taking into account the value of undeveloped land and tax pools, said Coyne, who calculates the deal at $24 per proven boe with an inferred 2.5% annual return on the acquisition cost based on the NPV of the resources. "This will significantly drop however if Whitecap reaches its stated target of a recovery factor of 15% as opposed to the 5.4% recovery rate that the reserves are currently based on."

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