The trading in Linn Energy (LINE) on June 18 can be best defined in one word -- irrational. Earlier in the day, the stock had been down as much as 5%. However, the stock has reversed this trend and is now up modestly for the day. A similar percentage size reversal has also been seen in shares of Linn Co (LNCO). Linn Energy currently offers a $0.725 per unit quarterly distribution, or $2.90 annually. At current prices, Linn Energy yields about 9.4%.
What Sparked This Decline?
The recent decline in Linn Energy's share price was caused by two separate events. First, there was yet another negative piece regarding Linn Energy posted by Barron's. The second was a conference call from a certain hedge fund in which it presented the bear case for Linn Energy.
On Saturday, Barron's wrote that Linn Energy's distributable cash flow, or DCF, is overstated and does not cover its distribution. The article also hinted at a 'surprise' disclosure buried deep in a recent SEC filing by Linn Energy. It should be noted that this is the third negative article published by Barron's this year. For the curious, here are the links to the other two articles: I II
The new Barron's article was basically a rehash of its prior work. It also repeated the same bearish opinions expressed by a certain hedge fund called Hedgeye Risk Management, or Hedgeye. Hedgeye argues that Linn Energy is worth no more than $17 per unit and also argues that Linn Co should trade at a discount to Linn Energy due to tax consequences related to the planned Berry (BRY) merger.
Hedgeye has also played an important part in the second event. The hedge fund posted a rather unconvincing presentation, which lays out its bearish case on Linn Energy and Linn Co. The only part where I somewhat agree with them is that the Linn Co/Linn Energy premium was rather high and should narrow. However, most of the other material presented was either already 'priced in' or worse, irrelevant. The market was clearly not buying what they were selling, as during and after this event, Linn Energy staged a sharp 'V' shaped reversal.
Has Linn Energy Found Support?
I have noticed that oftentimes a 10% yield acts as a temporary floor for many stocks. This is a nice round number and is oftentimes a level where income investors start to buy into a stock. To achieve a 10% yield, Linn Energy's share price would need to fall to $29.00 per unit. I would imagine that there are many bids at or around this level. This sharp reversal has me thinking that Linn Energy may have found a short-term bottom. At the low point, Linn Energy's stock price reached about $29.10. At this price, Linn Energy's yield would have been very close to 10%. Also, let us not forget that Linn Energy has plans to increase its distribution to $3.08 annually and change to monthly payouts once the Berry merger closes. The move to monthly distributions should add some stability to Linn Energy's stock price as it would increase the cost for shorting the stock. If you are short the stock, not only would you need to pay your broker to 'borrow' the shares, but also pay out the monthly distributions.
Another factor, which may give Linn Energy support, is that energy prices have been increasing recently. WTI oil is now trading near $100 per BBL while natural gas has remained at or near $4.00 per MCF for much of the year. WTI prices are now above where Linn Energy has hedges in place. In addition, the strength in natural gas prices could allow Linn Energy to possibly restart idled production. Linn Energy has in the past navigated itself through many different commodity price cycles while also paying out or increasing its distributions.
There has also been support coming from the institutional side. Leon Cooperman of the hedge fund Omega Advisors has stated that he is 'comfortable' with his investment in Linn Energy. Omega Advisors owns about 3% of Linn Energy's units and is its largest single investor.
Omega Advisors, Inc. is comfortable with our investment in Linn Energy, we are convinced of the professionalism and integrity of the company's management, we are optimistic about the company's future growth and financial performance."
Omega Advisors also mentioned that Linn Energy has most of its production hedged with swap contracts, which have no costs. This may undermine Hedgeye's argument that Linn Energy is overstating its hedging costs. It should also be noted that Linn Energy has about 100% of its pre-Berry oil and natural gas production hedged through 2016.
Today's action hopefully puts an end to the media circus regarding Linn Energy. I think that today's low may have marked a short-term bottom for the stock. The only negative remaining short-term risk for Linn Energy remains if the Berry merger somehow collapses. When thinking about the repeated bear attacks on Linn Energy, this actually seems to be the goal of the attacks. Berry owners are to receive a fixed amount of Linn Co stock (1.25 shares of LNCO for every 1 BRY share). As Linn Co has fallen in price, so has the premium for the Berry merger.
Upstream MLPs are high-risk by themselves. When you add in a determined short attack, this risk becomes nearly unbearable. Linn Energy is widely held by smaller retail investors. These types of investors tend to have lower conviction and will often sell stocks on any negative news or rumors.
Linn Energy no longer trades based on fundamentals. The stock is at the mercy of short sellers. If one hedge fund can cause this much grief, what would happen if a real negative event were to occur? Until the Berry merger closes, Linn Energy will be a volatile stock and a trader's paradise.
Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.