Goldman Sachs downgraded shares of Linn Energy (LINE) and LinnCo (LNCO) Tuesday morning citing the fact the company has recouped most of its SEC inquiry related losses and now needs to show operational improvements to drive prices higher. On Monday, I argued a similar case, noting that shares were within 5% of their pre-SEC level and that investors should take profits and look elsewhere in the E&P space. On news of the Goldman downgrade, shares fell 4%.
This morning, management held an eagerly anticipated conference call to discuss operational results, which provided investors with reason for caution. First, CEO Mark Ellis stated, "The inquiry is still ongoing. Investors should not draw any conclusions with respect to the inquiry from any future declaration by the Division of Corporation Finance that the Form S-4 is effective. They are separate events, and investors should treat them as such. As part of the inquiry, the SEC staff has requested documents and communications related to our use of non-GAAP financial measures and hedging strategy."
Many investors had taken the fact SEC had no comment on the most recent S-4 as a sign the inquiry was over. Mr. Ellis clearly stated otherwise, and there remains a risk of action against the company as a consequence. This suggests a disconnect between the stock price and reality as the stock had just recouped its SEC-related losses. Until and unless this inquiry is closed without action, I do not believe Linn shares will be able to trade above $32 while any action, however unlikely, could seriously impair the share price. The fact that the SEC is allowing the Berry (BRY) deal would suggest major action is unlikely, though management did stress that they should be treated as "separate events." News that the inquiry is still ongoing is inconvertibly bad for Linn as it caps upside while expanding potential downside in the coming months, making the risk/reward profile of LINE unfavorable in my opinion
If a person chooses to make up their own facts, then, they can justify anything. The truth is that LINE traded pretty steady at $38 after the BRY deal was announced and before the short attack and weak quarterly results. The SEC inquiry happened to ensue, but it's not reasonable to suggest the stock has recouped its pre-SEC level when it should be the combined effect of the short attack, weak quarterly results and the SEC taken together. So, I would argue the level is $38 and, if we reduce that by 8% for the increased dilution of the new deal, then, that takes it down to $35. So, if $35 is our starting point, what else do we know. First, there is another acquisition that has been made. Second, Q3 and guidance for Q4 is much improved. Third, BRY has outperformed expectations. And yet, the SEC inquiry appears to be unresolved, but the risk of any major impact appears materially reduced. All told, IMO the stock should trade between $32 and $35 right now. If they complete the BRY deal and prove the integration is accretive, thus raising the distribution at minimum to the previously projected $3.08, the stock should then move even higher (depending on any SEC news, of course). GLTA