Linn Energy (LINE, LNCO) announced that it was hiring advisors to help it explore strategic alternatives related to its capital structure. The company also borrowed $919 million from its Linn credit facility, fully using the $3.6 billion borrowing base under that facility. While Linn could likely continue for a while longer due to its hedges, management may have decided to bow to the near inevitable to get started on a comprehensive restructuring plan.
Linn's moves appear to have been prompted by the strong probability that it would have very limited (if any) credit facility borrowing capacity soon, and that the company's unhedged leverage ratio would be extremely high even with a significant recovery in oil and natural gas prices.
The Implications Of The Borrowing Base Drawdown
The borrowing base drawdown means that Linn is likely to face a borrowing base deficiency of $500+ million after its next borrowing base redetermination (currently scheduled for April). This makes it very likely that the company will not make any interest payments on its bonds past April, since the credit facility lenders would likely not permit Linn to pay over $400 million per year in interest to the unsecured and second lien bondholders, while there is also a major borrowing base deficiency. If the majority of its interest payments were going towards the credit facility lenders, I could see the lenders allowing Linn to manage a borrowing base deficiency for a while. However, with the huge amount of interest payments going to other creditors, the credit facility lenders have much less incentive to allow the company to continue as is.
There is also a decent chance that Linn will elect to skip its interest payments as early as February and exercise the 30-day grace period. Given that a restructuring appears inevitable within a few months, it may want to preserve its cash as much as possible.
Although some have suggested that Linn may be using the credit facility money to repurchase unsecured debt at pennies on the dollar, I think this is quite unlikely. One reason is that the company wouldn't be able to repurchase the majority of its debt on the open market due to the creeping tender issue. Perhaps Linn could repurchase $1 billion of its unsecured debt on the open market without running into SEC problems, but it probably wouldn't have needed to draw down its credit facility to do so, as the cost would now only be around $50 million, including accrued interest. To try and repurchase the majority of its unsecured debt would require a tender offer, and it seems likely that the credit facility lenders would put a stop to such a move, as the transfer of cash to unsecured lenders would damage credit facility recoveries.
Credit Facility Borrowing Capacity Could Decrease Substantially
As Linn's hedges roll off, the borrowing bases for its credit facilities would certainly be reduced significantly. I previously estimated that the company's combined borrowing bases could be reduced to $3.6 billion by Fall 2016 if oil is at $50 and natural gas is at $2.50-2.75 at that time. With the $500 million term loan and the $500 million minimum liquidity covenant, that would essentially allow for only $2.6 billion in credit facility borrowings. Linn would have needed to reduce its credit facility borrowings by $481 million by October 2015 to get to $2.6 billion in credit facility borrowings. That probably looked unlikely at the time when the company maxed out its credit facility borrowings.
With oil at $30 and natural gas at $2.10, Linn's combined borrowing base is likely going to be reduced by a greater extent than I previously expected as well. Given that I already thought there would be serious problems with its credit facilities if oil rebounded to $50 by the Fall, the current oil and gas prices indicate that Linn's credit facility would have likely ceased to be an available source of financing by April even if it didn't fully utilize its current borrowing capacity.
Still Generating Positive Cash Flow
The company's predicament is not caused by a lack of current positive cash flow, but rather, the likely contraction of its borrowing base. Linn Energy does still appear to be able to generate positive cash flow for now. Before the recent borrowings, Linn Energy had $2.181 billion borrowed under its Linn credit facility (excluding the $500 million term loan that is subject to the borrowing base) and $900 million borrowed under its Berry credit facility, for a combined total of $3.081 billion. This compares to $3.187 billion in borrowings in October 2015, indicating that the company was able to reduce its credit facility borrowings by approximately $106 million over the last four months. Linn's interest payments are concentrated more heavily in Q2 and Q4, so it managed to generate that positive cash flow despite the Q4 interest payments.
I had also calculated that with $30 oil and $2 natural gas, Linn would be able to generate $376 million in positive cash flow during 2016 if capital expenditures came out to $450 million.
Inability To Raise Additional Financing
Other than its credit facility, there aren't any ways for Linn to raise a substantial amount of additional financing. Any major asset sales would result in a borrowing base reduction, leading to the net proceeds from the sale going towards paying down the credit facility. As well, this would be a very poor time to sell assets. Additional debt financing is out of the question, given that its second lien notes dropped below 20 cents on the dollar. Equity raises would also generate only a limited amount of funds due to Linn's low unit price.
Very High Leverage Even With A Price Rebound
One of Linn's main challenges is that its leverage is extremely high even with an oil and natural gas price rebound. At $70 oil and $3.50 natural gas, its net debt-to-EBITDA ratio would be around 8x. At $90 oil and $4.00 natural gas, this improves to approximately 5.4x, which would still be considered highly leveraged. Linn's current financial structure requires oil to reach over $90 in the long run, which doesn't appear to be a sustainable situation, given the outlook for oil prices over the next few years.
Borrowing base contraction is something to watch out for with companies that would otherwise have positive cash flow in 2016 due to hedges. In Linn Energy's case, it is still generating positive cash flow, but faces potential borrowing base reductions that could result in all that positive cash flow going toward paying down its credit facility. The combination of limited future liquidity (due to borrowing bases being reduced below current outstanding borrowings), diminishing hedges and very high leverage ratios even with $70+ oil will likely push other companies into a restructuring scenario soon.
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