Very long, detailed article. Here is the author's conclusion:
With that caveat, and solely because the headline of the article implies that I will attempt to calculate a rough estimate of the intrinsic value on Linn Energy's units, here goes ...
Plugging in my own estimate for in Buffett's + - formula, and assuming the Berry merger does not go through, I estimate that the intrinsic value for Linn Energy's common units of somewhere in the range of $20-22 per unit. I assume a 10% discount rate (to reflect the higher risk in LINE relative to many other MLPs), an eventual yield of 9%, and a very small-to-flat growth rate in Linn's per-unit owner earnings.
Assuming the Berry merger does go through on the same terms initially announced (which is highly unlikely in my opinion), I think an investor could justify an intrinsic value of between $24-26 per unit using the same 10% discount rate, 9% exit yield and a small annualized growth rate.
Even these valuations could be quite optimistic, given that it appears clear to me that Linn is currently paying well in excess of its owner earnings. Forecasting any growth (other than negative growth) in owner earnings on a per unit basis is probably foolish in such circumstances, meaning the assumptions above may not be reflective of reality. For the reasons described above, paying out in excess of owner earnings is not long-term sustainable. Unless Linn cuts its distribution (which I think would actually be a good thing for Linn unitholders), Linn may actually show negative per unit growth in owner earnings.
Go look at a chart of PXD, then try to imagine some one writing an article about their accounting treatment of puts on SA. Nobody cares because their production and their revenue are increasing by leaps and bounds. What matters is how much money LINE will make in q3, which depends on their oil, gas, and NGL production, and how much money they make on their puts.
It is not just the shorts and SA articles that say that Linn is not covering the distribution/"owner earnings." Linn says it is not covering its distribution. Linn says its only plan for raising revenue enough to cover the distribution is merging with BRY. So the only real questions are: have NGL and oil prices risen enough to provide a sizeable bump in Linn's revenue in q3, how much money will they make in puts, will their Wolfberry and Bone Springs wells come through (probably in q4}, and above all will the BRY merger go through? If the answer to these questions are negative, Linn's unit price will go way down from here, no matter what they do with their puts.
What a transparent bunch of #$%$. You take an exceedingly complex situation and cherry pick the data you want to fit your purpose. You omit mountains of material data and supposedly resolve other data wildly out of context. I realize that you and your minions, rrb and diodia (if they are not your other aliases), regard yourselves as people who have all the answers. But unless you work for Linn and have access to all their current data and information in context you are just making a fool out of yourself with your Gordian Knot BS. You have no idea what the SEC is thinking, you have no idea what BRY is thinking and you certainly do not know what Linn execs have been doing since the last conference call to goose DCF and production. You just flap your gums for mental masturbation trying to scare others. Sad that this is how reduced you are as a person.
You are letting your emotions get the best of you.
State specifically what details you feel like have been taken out of context. Let's have an open dialogue about them. Let's separate the facts from the fancy.
As I've said before, I'm not a short. I've been investing in MLPs for 13 years. A couple of years ago I made the comment that Linn's natural gas hedges were falling and would impact DCF. I was attacked repeatedly by 1 poster in particular. I continued to highlight the issue as LINE made billions upon billions in acquisitions, with marginal accretion. Linn even failed to achieve their own accretion goal. The bulk of the accretive cash went to shoring up the huge hole in DCF. They've also levered up the balance sheet significantly. Now they are looking to make a $4 billion acquisition to dig them out of the hole. Are Linn investors concerned that Linn cannot achieve a 1.0x coverage ratio without acquisitions? Did Linn not allocate enough maintenance cap ex?
So, let's have an open dialogue and take the emotion and name calling out of it.
Does any intelligent person screen the stuff that SA puts out? (Clearly not). The article has myriad flaws. One very basic one is that one doesn't assume both a yield rate AND a discount rate. The risk factors going forward are inherent in the yield rate demanded by the market environment/business assessment as seen in the financial marketplace. One should use either a discount factor in figuring net present value of a stream of income (distributions) OR a market-imposed yield factor that is, in effect, an integration and weighting of all relevant risks and opportunities as seen by the market. So, if one takes the current $2.90 annual distribution with no growth for six years and a terminal (buyout) value in year seven of 10X the $2.90, at a 9% yield factor one gets a net present value of $28.87. OR if you use a 10% discount factor you get a net present value of the distribution steam of $27.51. Assume a modest 3% increase in annual distribution, starting two years out to be very conservative, and at 9% yield factor one gets a net present value of $31.44. All this is with no BRY in the assumptions. Add BRY and $3.08 distribution -- starting a year from now -- and growing at 4% annually, the NPV model at 9% yield factor give a present value of $33.94. There are at least a dozen other important factors SA missed in the analysis -- Fed Funds Rate, 10-year Treasury Bill Rate, Price of Oil, Nat Gas, and NGLs, improved infrastructure/improved productivity, the REDUCTION in RISK afforded by smart hedging, drop in risk as SEC winds up its inquiry, etc., etc.
Net-net, a very simple back of the envelope analysis gives an inherent value of about $27.5 to $34.
Why do you assume the annual distribution will rise 3% without BRY? Linn has said that their plan for restoring coverage to 1 x, as opposed to below .9 x where it is now, is the BRY merger. So I would love to know how you are forecasting production and revenue to get to 1.03 x or above, which requires an increase in DCF of 11 percent achieved without BRY. Linn has given no indication of how they might raise coverage other than by merging with BRY.
I think future revenues and production are far more important than the other factors you mentioned, and will determine Linn's share price. I do think an announced merger with BRY would provide a big lift to the share price.
Linn losing sight of the big picture caused this problem. They are generating .90x coverage on a $2.90 annualized distribution. So, if you extrapolate that out over 4Q's (remember, the market is forward looking), that would be DCF of $2.61/unit. If they had left the distribution at $2.52/unit, Linn would currently have coverage of 1.04x. Linn would probably still be trading in the high $30's and the Hedgeye ordeal would have blown over...
But Ellis wanted to make a name for himself by showing aggressive distribution growth, especially after a long period of stagnant distributions (prompting the very good and detailed Linn 'bond' comparison discussion). Ellis did succeed in making a name for himself, but unfortunately, he managed to show that he is more an E&P guy than an MLP guy. If you talk to a lot of the MLP guys, including ones that have worked at multiple MLPs, you'll find a lot of them have banker backgrounds. They look to make an industry fit the model (be it pipelines, E&P, propane, coal royalties etc) and therefore are successful. Make no mistake about it, execs need to understand that they are running an MLP, not an E&P company. It's an asset class. Many retail investors are not sophisticated and don't understand the nuances of the various industries they are involved in. You have to generate steady, predictable, stable cash flow and distributions. If that means running with a 1.3x coverage ratio to be able to absorb commodity price fluctuations, then so bit it.
Linn has damaged its credibility, it will take a lot of work to regain that investor trust...as in quarter after quarter of above 1.0x coverage ratio. If Linn proves it cannot maintain 1.0x coverage ratio without making acquisitions, then management ought to be fired as they do not have a sustainable model.
Very lengthy and of no use as it is fundamentally flawed at length.
Did the author ever get around to a sensitivity analysis to commodity price? Nope.
did the author point out the issue of put time and volatility premiums is moot by switching to swaps?
Did the author note that due to Obama's irrational American energy markets oil and gas based on mcfe is an inadequate measure?
Did the author note than all development capital can be tied to an asset. Sadly like hoghooter. How about mature assets like Hugoton having a lower cost of production on reconnections for example?
Clearly a long and epic effort. But it is not the Buffett method but the Graham and Dodd fundamental valuation Buffett uses.
Oh well it is so long I am sure the OLB can play with it for a very long time. As they do. Everything is a rock to underhand toss.
Why would the BRY merger go through when the price of the Linn Energy has fallen by 1/3.
BRY would be accepting a great deal of money less than the offer that was initially made.
The merger would only go through if Linn offers them more units which dilutes existing Linn