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Linn Energy, LLC Message Board

  • beemerxi beemerxi May 15, 2013 10:10 AM Flag

    BofA on Line Hedging

    Addressing controversies

    The issue under the microscope is whether management’s practice of acquiring
    puts, typically as part of an acquisition that is subsequently capitalized, inflates
    EBITDA as realized gains flow through. Some argue this cost should be
    expensed – and by avoiding the expense, distributable cashflow is higher than it
    would be otherwise.

    From our review of the issue, LINE has not defied any accounting rules;
    moreover, our analysis suggests that absent the ‘puts’, future distributions would
    still be safe. LINE management has attempted to address the controversy and
    has committed to avoid this hedging strategy in future. Our view can be
    summarized with the following points

    -LINE is the only E&P MLP with 100% hedged oil & gas production.
    Management’s policy has been to hedge ~100% of production for typically 4-
    5 years, seeing this as a strategic advantage vs peers – particularly in the
    eyes of “long only” institutional investors.

    -Providers of financing such as lending banks do not typically embrace
    companies’ hedging more than 80%-85% of PDP (proved developed
    production) on swaps. Thus, to achieve ~100% hedging, LINE management
    has used Puts to bridge the gap.

    However, from our review of the historical hedging strategy and from discussions
    with management, the majority of the ‘puts’ were purchased below the market.
    According to management, out of 40+ hedging transactions over the last 10
    years, only 7 were purchased ‘in the money.’ Regardless, management accepts
    that the controversy has impacted recent unit performance and is committed to a
    change in hedging policy to avoid any further ramifications from any perceived
    distortion on the strength of underlying cash flow.

    By our analysis, future distributions will be safe. If we remove the ‘put’ gains from
    our projected cash flow – which is fully paid – our analysis suggests LINE could
    still achieve an average distribution coverage ratio of 1.0x for 2013-2015.

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