03/25/13 12:15 PM EDT
LOOKING AT LINN ENERGY
Takeaway: Here's a deep dive into LINN Energy and the company's accounting practices.
Energy sector head Kevin Kaiser digs into the accounting practices of LINN Energy LLC (LINE, LNCO) and comes up with more questions than answers.
LINE is a Master Limited Partnership (MLP), a tax-advantaged corporate structure that traditionally attracts individual investors looking for a mix of above-average yield and safety. Oil and gas exploration and production (E&P) MLPs typically acquire and operate older producing oil and gas fields with low decline rate fields (approximately 10% per year). These fields tend to throw off decent revenues and, since the MLP does not pay corporate income taxes, the company distributes excess cash flow to its unit holders.
These so-called “upstream” MLPs typically grow through acquisition of producing fields, rather than through exploration, which is an expensive and capital intensive process. Simply, E&P MLPs are in the cash flow business, and the MLP structure mandates them to distribute the majority (+90%) of their excess cash flows to unit holders.
Today there are 11 publicly-traded upstream MLPs in the US. LINE is the largest with a $19B enterprise value. Pro forma LINE’s recent acquisition of Berry Petroleum, the stock trades at ten times 2013 EBITDA. LINE shares closed Friday at $36.40. Kaiser says his analysis indicates the stock is probably worth about $15 a share based on multiple of cash flow and net asset valuation approaches.
Are E&P MLPs Over-Valued?
Oil and gas wells are, by definition, declining assets, and cash distributions rely on the MLPs ability to manage its properties to sustain stable production – an difficult task, as any oil company executive will tell you. Kaiser believes the upstream MLP sector is overvalued and riskier than most investors recognize, but no company more so than LINE.
Kaiser points to two key generators of cash flow: hedging and maintenance capex.
In both cases, he says, LINE’s accounting practices appear nontransparent. Kaiser re-calculated certain of LINE’s key cash flow metrics using more conventional accounting approaches and arrives at the conclusion that LINE’s distribution is not sustainable. In the period 2006-2012, LINE paid out approximately $2.2 billion to unitholders. During that period – according to Kaiser’s calculations – actual free cash flow was a deficit of approximately $1 billion. In short, distributions are paid with capital raises as opposed to free cash flow. This cannot continue indefinitely.
Among key issues Kaiser raises are LINE’s accounting for their hedging. The purpose of hedging is to offset fluctuations in revenues from their oil and gas properties. LINE appears to be accounting for its options hedge strategy in a way that makes all put option transactions look profitable, and appears to be accounting for its hedge transactions as part of the company’s recurring cash flow.
Finally, Kaiser says there are limits to how far a company can take its growth-by-acquisition strategy. MLPs buy assets when markets are strong, and often overpay. Then they suffer in weak markets, making the group highly pro-cyclical – meaning it tends to rise and fall together with broad market trends. Kaiser says LINE will need meaningful capital expenditures to maintain their cash flow stream.
LINE may be the tip of a very large iceberg. Investors who are enjoying above-average returns from high-yield MLPs should look under the hood. While it is too early to say this whole business model is in jeopardy, LINE looks like a company trying to stay ahead of the curve by taking advantage of a series of accounting strategies. We do not mean to imply that there is anything improper about what LINE is doing. It should be enough warning for investors that their books are not transparent. Accounting rules have been so distorted by Congress and lack of clear regulation that no one needs to break the law in order to pull the wool over investors’ eyes.
You have some very smart people at JP Morgan and other investment firms saying Line is worth $40 a share if the Berry acquisition occurs and $35 a share if it doesn't occur. I am sure they "dig into" the financials and accounting of Linn Energy more so than Ken kaiser.
Sentiment: Strong Buy
Have you ever heard the phrase...you put 100 Economists in a room and none will agree! His degree is in Economics according to you...not Finance or Accounting. If you said his degree was Finance and he was a CFA...then I would agree with you regarding the credentials.
Also, ever thought of this...ERNST & YOUNG LLP are not rookies either and would have to have signed off on their practices. In the days subsequent to the Enron world, these auditors have become far more diligent.
Lastly, I have seen in the past Barrons with very cozy relationships with Hedge funds and others write hit pieces that benefit these individuals who spoon feed them stories. In almost every one of these Hit Pieces, the comments made from the company being hit were never included in the story. Further, in almost every case I have seen, Barrons later was found to be incorrect in their stories and had to "clarify". That, however, was after the short got out and made their money...how convenient. One must be suspect of these stories and, in my opinion, when a hedgefund who is short spoons feeds a story and reaps the benefits from this action.
Can't get over how this is public for months detailing precisely what Kaiser claims the issues are, and yet, BRY must have considered these comments and still was willing to accept a stock deal and people like Cooperman are able to review this information, conduct his own due diligence, and disagree with Kaiser's conclusions (putting his reputation on the line at the same time). Numerous analysts from quality firms have had the same opportunity to assess Kaiser's opinion. At this point, it only matters what the SEC thinks, but it would seem the odds are for a good outcome and that this is a good time to be accumulating shares.
Check this Ken Kaiser dude out what a record .instantcheckmate says it all Hey Ken are you a ex-cellmate of Keith's you guys all are going back to the pokey with this Linn Energy charade what a bunch of criminal nerds
BS. Nothing was exposed.
What has happened is a good American company treating American associates with respect has been damaged by running a short game.
No superior analysis. No superior insight.
Just a Progressive hedge fund manager running an operation and making money by destroying.
What Ivy league degrees are for in this age of moral relativity material nihilism.
LINE has been damaged. But it is not out. Assets are real and so are the cash flows from which distributions are paid.
That and the Barron's article that same month is what started the SEC to look in to this and to make a decision to do the informal investigation and to ask LINN Energy for all the working documents. Unfortunately, the SEC is slow since they are understaffed and have tens of thousands of companies to oversee. Get it?
Yeah, but his calcs (based on his "crack" research) charged all capex to DCF, and for LINE, that's just wrong. I don't need to go into that again, but the dude did not "look under the hood", he used 10K numbers in a misleading way.
Fortunately the SEC doesn't have smart people working there so they won't catch the complex accounting and derivatives LINN Energy is using to disguise their cash flow. Remember, the SEC never figured out Bernie Madoff never did a single trade for 30 years and he was only caught when Bernie's sons turned him in to the SEC and FBI.
Ken Kaiser is the analyst for Hedgeye.
He graduated summa cume laude with Economics degree from Princeton University.
Princeton University is ranked #1 in Economics in the United States
Rank School name Score
#1 Harvard University Cambridge, MA 5.0
#1 Massachusetts Institute of Technology Cambridge, MA 5.0
#1 Princeton University Princeton, NJ 5.0
#1 University of Chicago Chicago, IL 5.0
It appears the economist objects to the dcf model. He should also be transparent about his view. I am no apologist for E&P MLPs... there are too many moving parts (hedging, commodity pricing near and long term, reserve calculations, costs to explore and produce) for me to have interest in them.
There are probably times where an MLP capital raise comes at a theoretical point so close to the distribution payout that one could argue the payout is coming out of the recently raised proceeds from the secondary. I saw this charge raised on EPD several years ago. LONG TERM, the longer the MLP is in existence the less significant the charge that MLPs deliberately time their capital raises becomes insignificant or of no LONG TERM importance.
LINE hedges almost all of its future production so I view this as a war between this economist and Leon Cooperman who is a remarkable businessman and investor. I suspect the economist is relying on economic measures of variables that businessmen look past because decisions made based upon economics are entirely different in scope than the way a businessman makes a business decision.
In the end we will either find out there is some truth to this or the shorts just piled on and when they get off this ride LINE will recover. Shorts are not going to hang in much longer knowing they will start paying a distribution yield over 12%..... the game gets interesting because while it is true the shorts have had their way there are a lot of longs ready to jump in for that remarkable yield hoping for more assuming the Barry Petroleum deal goes thru and the distribution is raised another eighteen cents/share.
Nobody has claimed he isn't smart. His motives are the ones that are in question. People often twist things to meet an agenda. Just watch the George Zimmerman trial and the reporting on it. Just find it hard to believe Cooperman's people, the bank auditors involved in the BRY deal, and the SEC involved the LNCO IPO didn't find the same thing, especially considering the results on the price of the stock. 40 to 8.