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.
the corrupt and criminal IRS should investigate someone???
They should put every single IRS agent in jail for a year as a penalty for their collective criminal actions, since no one will identify who did it.
ChicagObama style trickle down corruption. Sorry, Obama, the rest of the country doesn't want to live with the corruption that you benefit from in Chicago.