Linn Energy (LINE) is an oil and natural gas E&P company. It had approximately 4.8 Tcfe of proved reserves as of Dec. 31, 2012. It is now in the process of buying Berry Petroleum (BRY) for $4.3B. With that acquisition LINE's proved reserves will go up to approximately 6.4 Tcfe. 62% of these are proved developed. The combined company's reserves will be approximately 54% oil and NGLs and 46% natural gas. They will have approximately a 16 year reserve life index. Berry Petroleum also has approximately 3.8 Tcfe of probable and possible reserves. Developing these should help LINE maintain production as older assets move farther down on their production curves.
On March 18, 2013 LINE and Linn Co (LNCO) announced that they have received early termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976. This removes the last regulatory stumbling block. The transaction is now only subject to the normal closing conditions. These include the approval of BRY and LNCO shareholders and LINE unit holders. At this time all companies expect an expeditious closing, which should allow the transaction to close by June 30, 2013.
For those who don't already know, Linn Co is a shell company that owns units/shares of Linn Energy . Its reason for being is to convert LINE's LP distributions from ordinary income tax status to "ordinary dividend" tax status. If you want to receive ordinary dividends, you probably want to own LINE by owning LNCO. This can be a considerable tax savings for many. In the above deal, LNCO is being used in a stock for stock exchange with BRY. In this way, BRY owners will get ordinary dividend shares for the ordinary dividend shares they turn in. LINE will then give LNCO units of LINE in exchange for BRY assets. The total cost of the deal for LINE will be approximately $4.3B. This is thought to be a relative bargain for LINE. Plus it immediately makes LINE much more oily, which has been one of its recent goals.
One author recently took cheap shots at LINE in order to pump another stock. He claimed that LINE paid for its hedges instead of using no cost collars. He tried to point out that this was extremely costly to LINE.
Let's examine the relative hedges of LINE and Pioneer Southwest Energy Partners LP (PSE). LINE has 100% oil and gas hedges through 2016. For oil these are priced at on average $95.57 per barrel for 2013. For natural gas they are priced on average at $5.31 per Mcf. In both cases LINE has used a combination of swaps and puts.
By comparison PSE has approximately 65% production coverage with hedges. Its hedges consist of swaps and three way collars. For oil the swaps cover about 54% of production at a swap price point of $81.02. The oil three way collars cover about 31% of production. They have the following price structure: a short call of $116, a long put of $88.14, and a short put of $73.14 per barrel for Q1 2013. For natural gas, PSE only has swaps that cover approximately 35% of natural gas production at $6.89/Mcf. All told this means that PSE has approximately 65% of its total production hedged versus LINE's 100% hedging coverage. This isn't good for this kind of company. Having reliable revenues is extremely important in this business.
Even with the above, the picture remains confusing. For an example let's directly compare Q4 2012 realized prices with hedging. For Q4 for PSE the price realized for oil with all hedges was $79.39/barrel and the price realized for natural gas with all hedges was $5.16/Mcf.
For LINE in Q4 2012 the price realized for oil with all hedges was $93.63/barrel, and the price realized for natural gas was $5.21/Mcf. In other words the full effect of the hedging (or non-hedging) on realized prices for natural gas in Q4 for both PSE and LINE was almost a wash for natural gas in Q4 2012.
However, LINE profited greatly from its oil hedges relative to PSE in Q4 2012 as LINE realized +$14.24 more per barrel than PSE. Therefore, the writer of the article I read decrying LINE's hedging as a losing strategy was highly flawed was simply incorrect for the current market (and indeed in almost every situation). I point out that the professional analysts seem to agree with me, when they give LINE a mean recommendation of 1.8 (a buy) versus the mean recommendation they give PSE of 3.0 (a hold). There is no need to panic about LINE's hedging strategy, it is a good one.
That author also brings up the relative debt issue. However, LINE is acquiring debt quickly because it is growing quickly. For instance, the BRY acquisition will increase LINE's production by about 240 MMcfe/d or about 30%. It increases proved reserves by 34% (about 1.65 Tcfe). Including organic growth, LINE expects to grow production by 45% in 2013 alone. The following charts show the growth before 2013 for reserves, production, adjusted EBITDA, and annualized distributions.
PSE may not be acquiring debt quickly, but it is also not growing. The following chart shows PSE's total production growth from 2010 to 2012E. This amounts to less than 20% growth for all three years combined. In other words, PSE's growth does not begin to compare to LINE's. That author also decries LINE's cash flow compared to PSE's, but again this is an issue of growth. LINE perpetually spends virtually all of its cash flow on new investments. This means its net cash flow figure does not compare well with PSE's, which buys very few new investments. The comparison is close to meaningless.
In other words, I consider that article to be a pumping article on PSE through slurs against LINE. There is very little truth to these slurs. Since I was a bit concerned myself, I thought a few other LINE/LNCO investors might have been concerned by it too, so I did the homework.
LINE is still an excellent company, and it is still a great investment. With its great hedges it should be able to survive a simultaneous EU and US recession well. I am sure it would lose value in sympathy with the overall market and with oil and gas prices in the case of a US recession. However, it would soon bounce back up on an economic recovery. Meanwhile you would get to collect its 7.86% dividend.
Further the BRY acquisition is expected to raise LINE's $2.90 annual distribution in 2012 by $0.40 per unit in the first year after the acquisition. This should make LINE shareholders/unitholders happy. By comparison again PSE had a $0.50 quarterly distribution on the November 3, 2008 record date. It had a $0.52 quarterly distribution on the February 4, 2013 record date. I think most people would prefer LINE's track record. LINE is a buy.
The five year chart of LINE gives some technical direction to this trade.
The slow stochastic sub chart shows that LINE is neither overbought nor oversold. The main chart shows that LINE has been in a consolidation pattern for over two years. The purchase of BRY might be just the thing to push the stock price upward once again. The fundamentals definitely bias any move to the upside. This all makes LINE a buy. The mean analysts' recommendation agrees with me at 1.8 (a buy).
Still the world economic situation is tenuous. The EU recession seems to be worsening. Both Spain and Italy are in terrible shape. The new taxes and the sequester may be enough to push the US economy into a recession. It grew at only a +0.1% rate in Q4 2012. With this in mind it is probably better to average into LINE. In this way you should get an average good entry price, even if LINE falls in sympathy with the rest of the market in the case of a US recession.
NOTE: Some of the above fundamental financial data is from Yahoo Finance.
Good Luck Trading.