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Arbs struggle to capture Berry spread

by Scott Stuart  |  Published May 2, 2013 at 9:39 AM
Shares of Berry Petroleum Co. trade at an uncommonly wide spread to its $2.9 billion merger with LinnCo LLC and affiliate Linn Energy LLC, but is there a way to trade it?

Berry Petroleum entered a stock swap Dec. 20 with LinnCo for 1.25 of a LinnCo share for each share of Berry. Berry is an oil and gas exploration and development company with assets from California to Texas. LinnCo is a limited partnership holding units of Linn, which develops oil and gas properties.

The companies expect the deal could close by the end of June. The registration statement for the units to be issued in the merger was filed March 22.

The deal requires the approval of shareholders of Berry, LinnCo and Linn. Some arbs following the transaction do not see any issues with it closing. The merger does require the approval of the Federal Energy Regulatory Commission. Berry has electric generation in California that powers its own operations, but the company also sells energy to utilities and so FERC has to approve the change of control.

The deal spread has been wide since the transaction was announced because LinnCo units cannot be readily borrowed for short sales. As a consequence, risk arbitrageurs cannot easily hedge the deal to capture the spread.

Also, since LinnCo is an LP, funds holding the shares on the deal close face a tax difficulty because their investors become liable for individual taxes related to the LinnCo units. So funds would shy away from owning LinnCo, but if the deal can be traded they could hold a position until shortly before the close and unwind it prior to actually owning LinnCo.

If LinnCo could be shorted, another issue is the relatively high dividend LinnCo pays: about 73 cents a quarter.

When the Berry deal spread was $2 and change following the deal announcement, this all seemed academic. But in recent weeks, the spread has grown wider. In recent days Berry has traded at a spread of about $5.20, without regard for the LinnCo dividend, to the value of the stock swap.

One approach to trying to capture some of that spread has been to short a comparable security, such as the Alps Alerian MLP ETF, ticker AMLP, which correlates well to LinnCo, an arb said.

There have been some concerns about LinnCo accounting, but that looks like water under the bridge and accountants have signed off on the deal, an arbitrageur said. When the proxy clears the Securities and Exchange Commission and a date is set for the shareholder meeting, the spread should narrow, he said. Having a more certain end date, which means holding a synthetic short for a limited time, will encourage arbs to look for ways to trade the deal, the arbitrageur said.

At a spread of $5, just going long Berry has some prospects, another arb said. LinnCo shares would have to decline about $4, or 9%, between now and the deal close before being long Berry produced a loss, the arb said.

At its current price, LinnCo offers about a 7% dividend yield, which should offer support to the shares, he said.
Tags: Berry Petroleum | Federal Energy Regulatory Commission | FERC | Linn Energy | LinnCo | SEC | Securities and Exchange Commission

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Scott Stuart

Senior Writer: Arbitrage

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