A surprise disclosure from Linn Energy, buried in a recent regulatory filing related to its planned merger with Berry Petroleum, supports the view put forth in Barron's that the oil and natural-gas producer's distributable cash flow is overstated and doesn't cover its distributions to investors.
One of the key controversies surrounding Linn, which is structured like a master limited partnership, is the accounting for its energy derivatives in its distributable cash flow, a key financial measure for MLPs. Distributable cash flow (DCF) is the basis for Linn's distribution, the MLP equivalent of a dividend. Linn has a market value of $7.5 billion, plus $6 billion of debt.
Linn has realized above-market prices for its natural gas due to its use of derivatives, including in-the-money put options. This has allowed the company to get more than $5 per million British thermal units for its gas when the market price has been $4 or lower.
Until the recent disclosure in a footnote on page 257 of a revised proxy for the deal, it wasn't possible to calculate the impact of the puts on Linn's distributable cash. And contrary to the impression the company has given this year in presentations aimed at thwarting short-sellers, that expense is significant. During the first quarter, the cost of puts that settled in that period was $43 million, or nearly 30% of the company's reported distributable cash flow of $150 million.
The drop in Linn units could imperil the Berry deal. Linn will pay for Berry with shares of LinnCo (LNCO), a corporation created by Linn that holds Linn units. LinnCo trades at $37, a six-point premium to Linn, but there is reason to believe the price of the less-liquid LinnCo shares will converge with the price of the Linn units, making the deal unattractive to Berry holders. LinnCo's current premium could reflect the difficulty of shorting the stock.
What's more, there could be adverse tax consequences from the Berry deal for LinnCo holders, starting in 2016.
But isn't that what a hedge is supposed todo. If you buy a property that produces NG and can make money if the current price of NG i stays at a price $5 per mbtu but you are afraid that the price of NG will drip, you can buy insurance of against that risk buy selling a put (or doing a swap). If the price drops to $4 mbtu your insurance pays $1.
Could the $43 million be like in insurance payment for the drop in NG prices ?
It wasn't so much that Barron's was right as much as LINE was SO WRONG in leading its investors to believe they could ever duplicate the incredible hedging they did prior to the financial crisis which carried the day forward for them for several years but that was going to come to an end and the inability to duplicate near perfection would have to result in an alteration to their distribution growth policy.
Anyone who believes ANY E&P MLP can continue to raise their distribution growth outlook year after year by 5% is not thinking right at all. It is impossible for any E&P MLP to stake or state such claims and investors simply got taken in to a situation where management was either just as delusional in regard to their abilities as LINE's investors who now have realized losses of capital representing several years distributions.
I tend to believe LINE mgmt. always knew this day was coming and there was great hope they could get the Berry deal done before anyone saw as the systematic elimination of those great hedges had to make it more and more difficult to make any claim to distribution growth with the same confidence management could legitimately lay claim to in 2010 through 2012.
I personally think the E&P MLP play is over. The money is dead and stock prices going back to days where you get 300-500 basis points more of yield in return for very little growth of capital because growth of capital in an E&P is dependent on too many moving levers; hedging, reserves, new land acquisitions, new drilling programs, higher drilling costs which is becoming a bigger issue..... EVEP cannot afford to drill on its Utica to justify selling prices it wants for its land.... the ultimate irony.
I don't think that's correct. When LINE put the hedges on when the price was high; the price of NG was high; since then the price of NG dropped and what they lost in selling NG they made up with the hedges. That's the point of hedges.
Now the price of NG is low, and LINE still hedges against NG going lower. If NG goes up, LINE makes money on the NG but lost money putting the hedge on. With he hedge, you are assured of a constant stream of income; without hedges you could make a lot and lose a lot.
You hit the nail on the head. Linn's superb hedges put on in '07/'08 are rolling off, creating a huge DCF shortfall.
This forced them to make billions in acquisitions to shore up the shotfall. The Berry deal is just the latest in a series deals. If it falls through, it won't be the end of the world for Linn, but make no mistake about it, Linn is still desperately seeking to position themselves where they can be in steady state mode. They need to be able to produce enough DCF on an appropriate sized asset base that based on normal futures prices.
Nice post. Very self serving for "shorty" at least.
If, could, probably, and should were the only words that were close to the truth in the post.
Just make sure you pay the dividends shorty.
Thanks in advance.
When oil is going up, there are always people that say "oil is going to $200/barrel".
When oil is going down, there are always people that say "oil is going to $40/barrel".
Neither group has a clue, they're just touting their positions.
As are you.
Funny how you come out with your "analysis" of one tiny piece of Linn's, over 257 page proxy, while ignoring significant production increases, revenue increases, and overall explosive expansion of their business. If you take out any statement you made that include the phrases "could have" or "might be", you've got nothing.
Unfortunately, you're incorrect. Linn has suffered production DECLINES along with revenue. This year they are looking at a 5% reduction at least (ex-Berry). Clear away all the smoke from the hedges, and they have been losing ground for several years despite all the acquisitions.
Besides, it wasn't "my" analysis - it was Barron's, and the sources they used.
There are so many "COULD BE" statements in this article. Seems clearly produced to create fear, raise anxiety, etc. over the SAME issues already discussed and rebutted. LINN is a great company!
Sentiment: Strong Buy