Important Note: This article is not an investment recommendation and should not to be relied upon when making investment decisions - investors should conduct their own comprehensive research. Please read the disclaimer at the end of this article.
Linn Energy (NASDAQ:LINE) and LinnCo, LLC (NASDAQ:LNCO) announced that Linn Energy has retained Lazard as financial advisor and Kirkland & Ellis LLP as legal advisor to assist the Board of Directors and management team with exploring strategic alternatives.
According to the press release, the purpose of the process is "to strengthen its balance sheet and maximize the value of the company." (Given the circumstances, the statement may raise eyebrows.) The press release also mentions a "comprehensive solution" that the company believes it can implement.
In the same press release, LINN disclosed that it has drawn ~$919 million from its credit facility, which represented the entire undrawn amount that was available. Total borrowings under the credit facility are now $3.6 billion. The Berry Petroleum credit facility is also fully drawn at $900 million, including $250 million of restricted cash posted as collateral. The move indicates that a reorganization is very likely.
LINN's move to draw the full amount under its credit facility provides the company with liquidity to pay all its current bills, including fees to its financial advisers and lawyers. The move is obviously detrimental to the company's senior lenders who now have a much larger value at risk in what is obviously a dangerously distressed situation, even from the perspective of a first lien lender. On the other hand, the move may benefit second lien note holders as the low-cost "captive liquidity" will be a favorable factor in sustaining business operations should LINN file for a reorganization.
One question that many holders of LINN and LinCo equity may be asking themselves is whether a reorganization solution is feasible in which equity holders would be able to receive some recovery.
In order to assess possible outcomes, it might be helpful to look at the PV-10 value of LINN's proved developed reserves.
As a reminder, at the end of October 2015, LINN disclosed an internal PV-10 estimate for its proved reserves based on October 8, 2015, strip prices. It appeared that the estimate was a summary of the valuation that the company had provided to its senior lenders in the context of the regular semi-annual borrowing base redetermination.
- The PV-10 value of the company's proved developed reserves, plus the value of hedges, was ~$7.2 billion.
- The value of proved undeveloped reserves was an additional ~$0.9 billion.
The escalating price deck used by the company reflected Nymex oil prices of "approximately $50-$60 per barrel" and natural gas prices of "approximately $2.60-$4.35 per MMBtu."
Even at these price decks - which are significantly higher than the current strip curves - a massive gap obviously exists between the company's total debt amount and the net value of its underlying assets.
It is important to remember that the PV-10 value does not capture the impact of the company's corporate overheads. As a reminder, LINN's annual G&A run-rate was over ~$250 million, using last year's metrics. If I were to capitalize LINN's G&A at a 10x multiple, the net value of the assets would be reduced by as much $2.5 billion.
Even if LINN is successful in implementing a relatively quick and painless "prepack," any reorganization is an expensive undertaking. Significant value dissipation will inevitably occur in the process.
Furthermore, the company may become subject to multiple litigation cases. Complex, multiple claims and multi-party litigation may make the reorganization a protracted and costly process, making a big dent in the company's recoverable net worth.
The biggest concern, obviously, is the outlook for commodity prices. Let's not forget that LINN's asset base is predominantly an aggregation of mature assets scattered over dozens of operating areas. Mature assets tend to have a declining production profile with high - and, importantly, increasing over time - operating costs. As such, the company's asset base is characterized by high operating leverage: a relatively small move in commodity prices creates significant changes in the value of the assets.
As a result, one could speculate that the company's first lien lenders may have a strong case that under the current strip curves the value of the company's assets - after factoring in the overheads that are required to keep this eclectic collection of properties in operation - is lower than the amount of first lien borrowings outstanding. Senior lenders also may scrutinize the company's internal reserve assumptions which may impact the value calculation.
So the right question to ask may be, what is the likely recovery for second lien note holders?
Some recovery for second lien holders is certainly not impossible. A reorganization process, should the situation unfold in that direction, could take significant time. In the meantime, the trajectory of oil prices are difficult to predict. One can certainly imagine an optimistic scenario where a strong cyclical upturn in the industry comes to rescue, providing a market and more favorable valuations for LINN's assets. However, one also can conceive of more pessimistic scenarios - and the market appears to discount a relatively high probability of pessimistic scenarios actually materializing.
Where does LINN go from here? LINN's unsecured notes are trading at low single pennies on a dollar. The price effectively reflects an expectation that LINN will make no additional coupon payments and, therefore, a filing is imminent.
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