Linn Energy (LINE) is one of the most interesting cases in the master limited partnership universe. The partnership has been through a lot over the last few months and it looks like the struggles will continue in at least the short-term. Most recently, the company was making some strategic changes. It was moving away from undeveloped assets towards mature assets. The reason behind the move was the inability to raise enough cash flows to develop these assets.
Linn Energy already had a substantial capital expenditure, which included the expansion capital as well as the maintenance capital. The advantage of swapping undeveloped assets for mature fields is that the company saves capital expenditure. However, as the mature fields are already in operation; it increases the operating expenses of the business substantially. In robust market conditions, this is a very solid strategy. This means that the company can grow production at stable rates and enjoy the rising commodity prices. There is no delay in production growth.
On the other hand, low production growth rates and falling commodity prices is a very unfortunate combination. Linn Energy is currently facing the same scenario. As a result, the unit prices have fallen by more than 60% over the last twelve months.
Since the start of December last year, the unit has been fluctuating in a small band. Small rises in the stock price has been followed by declines of almost equal magnitude. The timing of the commodity prices slump could not be worse for Linn Energy. There were already doubts about the partnership's ability to meet its cash distribution obligations - the falling commodity prices have taken these fears to the next level.
Debt has been a problem for the partnership in the past. At the moment, Linn Energy has total long-term debt of over $10 billion which is almost 2.5 times the current market cap. The partnership pays about $600 million in interest expense alone. On the other hand, the unit holders get around $827 million in the shape of annual cash distributions. Interest payments are around 72% of the total cash distributions. This is a massive portion of cash flows that goes towards servicing the debt. This brings me to the most recent news regarding the company: the secondary unit offering. Linn Energy is offering 16 million units at $11.79 per unit. One wonders about the timing of the issue as the stock is trading 60% below the level of a year ago. However, this move is the one that the company has to do at the moment.
The current debt levels mean that Linn Energy does not want to go to the debt market as it will further deteriorate the financial position of the company. Furthermore, bowing with such high leverage (debt) makes your negotiation position awfully weak which might result in restrictive covenants. So in these conditions, I believe this was probably the most feasible option for the partnership. The proceeds from the offering ($181-208 million) will be used to cover the credit facility. The offering will have a dual impact on the existing shareholders: first, it will dilute the holdings immediately, and secondly, it might also have an impact on the distributions.
At the current distribution levels ($1.25 annual per unit) the burden on cash distributions will increase by $20-23 million. Based on current price levels, the yield is over 11% -- one wonders borrowing might have been a cheaper option. However, as I said above, the decision to issue new units seems mainly focused on preserving the current condition of the balance sheet.
Having said that, I believe Linn Energy is still an attractive pick - especially if the stock goes further down due to the secondary offering. Two things should be kept in mind: first, the stock is giving an extremely attractive yield, which can prove to be a good source of income until the recovery starts. Secondly, the equity value (break-up value) of the partnership is $4.544 billion while the total number of shares (after the new issue) is 347.4 million. So according to the break-up value calculation, the value per unit comes out to be $13 - this value is 15% higher than the last day's close ($11.30). In other words, the unit is trading at a 15% discount to its break-up value. Add 11% yield and the total return will reach 26%.
The above paragraph deals with the prospect of liquidation. I do not think there is a chance of that happening. As I mentioned above, the company has improved its assets portfolio and the addition of mature assets will allow it to grow at a sustainable rate in the long term. However, Linn Energy will have to wait for that to happen as I believe the commodity prices will remain under pressure over the next 12-18 months. However, as the commodity prices stabilize, the unit prices will start to rise as the partnership will be able to grow at a sustainable rate.
Disclosure: I am not a registered investment advisor and the views expressed in this article are my own. These views should not be taken as an investment advice or recommendation to buy or sell the shares. Investors should conduct their own due diligence before making an investment decision.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.