Linn Energy: Moving Past The Exchange Offer

| About: Linn Energy, (LINEQ)

Summary

Linn's exchange offer expired on April 25th. There was a surprisingly low level of participation as of April 15th.

With the exchange offer completed, there is a high chance of restructuring news soon, or at least an update on the progress of negotiations.

Increased oil and gas prices are likely too little and too late to make a difference for Linn.

The increase in oil and gas future prices since late February is only one-third of the increase needed for Linn to reach breakeven without hedges.

Linn's unhedged breakeven is around $70 oil and $3.50 natural gas or $65 oil and $4 natural gas.

Although natural gas prices and oil prices have increased substantially over the past couple months, the rate and size of the improvement doesn't appear to be enough to offer Linn Energy (NASDAQ:LINE) a lifeline. The company appears to be well on its way to restructuring, with the exchange offer now out of the way. If Linn wants to maintain production, it wouldn't reach breakeven without hedges until $65 oil and $4 natural gas or $70 oil and $3.50 natural gas. Forward strip prices remain well below those levels.

Restructuring To Potentially Start Soon

Linn Energy extended the deadline for its exchange offer to midnight, New York City time on April 25. This appears to be the only extension as there has been no additional notice about another extension. Linn's ability to further extend the deadline is probably limited by needing to limit the exchange to April. If the exchange extended into May, that would potentially prevent Linn from going forward with restructuring, as any debt reduction that is consummated in May would result in cancellation of debt income [CODI] being passed on to anyone who still held units at the beginning of May.

Surprisingly Low Participation Rates

An interesting thing is that the participation rate for the exchange offer has been quite low so far. As of April 15, approximately 55.5 million Linn units had been tendered, which represents approximately 24.5% of the units not owned by LinnCo (NASDAQ:LNCO). Given the potential adverse consequences of holding Linn's units during a restructuring, I would have thought that the participation rate would be much higher.

The low participation rate may be partly due to a lack of awareness. Linn sent out materials about the exchange and the exchange has been well covered on Seeking Alpha. However, it appears from the comments on a recent article that there are quite a few people who only recently became aware of the exchange and the potential CODI issue.

As well, there seems to be a lack of participation in offers that allow one to avoid negative consequences, but have little in the way of other positive consequences. With the exchange, one could likely avoid the negative consequence of CODI being passed on to unitholders. However, doing the exchange also could require a bit of time talking to brokers and perhaps a small broker fee.

Goodrich Petroleum (GDP) recently made offers to unsecured bondholders and preferred shareholders that involved a choice between a small recovery (in the form of common shares) and no recovery (if the offers didn't receive the required participation levels of 95% of unsecured bonds and 50% of preferred shares). The tender rate fell well short at 62% of unsecured bonds and 43% of preferred shares.

I think in these cases it would probably take a positive consequence (such as gaining additional shares if you tender) for participation rates to be high.

Notes On Balance Sheet Value

I don't pay too much attention to the listed value of oil and gas properties on the balance sheet since that often does not reflect market value or the value used in a restructuring. Linn's oil and natural gas properties have a net value of $7.02 billion on its balance sheet, but the standardized measure of discounted future net cash flows at SEC pricing is only $3.03 billion. In Linn's case, "The carrying values of proved properties are reduced to fair value when the expected undiscounted future cash flows of proved and risk-adjusted probable and possible reserves are less than net book value."

So it appears that some of Linn's properties may remain on the balance sheet at far higher than "fair" value as long as the listed value on the balance sheet is lower than the future cash flows from those properties at a 0% discount rate. That leads to the potential discrepancy between balance sheet value and market value as nobody is going to pay PV-0 for the properties.

Still Far From Breakeven

Although oil and gas prices have improved in recent weeks, Linn is still far from being able to break even without hedges. Linn's $340 million capital expenditure budget for 2016 (including $250 million in oil and gas capital expenditures) is expected to result in a 6% to 14% production decline from Q4 2015 levels. This also means that 2016's exit rate is likely going to be 15% lower than 2015's exit rate. Even if prices recover substantially, the lower production levels are going to find it hard to support Linn's interest costs, while maintenance capital expenditures are obviously much higher than $340 million.

Based on production levels of under 1,000 MMcfe per day, Linn needs closer to $70 oil and $3.50 natural gas to break even without hedges and maintain its production. A higher natural gas price such as $4.00 would reduce the oil price needed down to $65.

While oil and gas prices have improved significantly since late February, 2018 oil futures appear to be around $48.50 and 2018 natural gas futures appear to be around $2.95. This is still well below Linn's breakeven point. The improvement in oil and gas futures from late February lows has been only around one-third of the total improvement needed for Linn to hit breakeven.

Conclusion

Improvements in natural gas and oil pricing may have resulted in some hope that Linn can pull a rabbit out of its hat, but Linn really needed oil and gas futures to go up by three times the amount that they increased during the last two months. The 2018 futures are still a little bit below $50 oil and $3 natural gas, which is well below what Linn needs to break even and would probably result in around $500 million in annual cash burn without hedges and with maintenance level capital expenditures.

With the exchange offer ending, I expect Linn to make announcement about restructuring soon (either to announce a plan or to update on the progress of negotiations).

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