It's not news that prevailing oil and natural gas market conditions have drove down shares of Linn Energy (NASDAQ:LINE) to penny stock territory. The company has been cutting expenses and reducing its debt burden. But in a recent announcement, the company reported that it borrowed $919 million from its credit facility, which was the remaining untapped amount under this credit facility. Linn Energy Also reported its plans to change its balance sheet without providing any specifics. After-hours trading, LINE plunged by 26%. Let's break down this recent news.
Over the past several months the company has been reducing its cash burning rate by eliminating the distribution to its unit-holders, reducing its operating costs and capital spending. The company also cut its debt burden by $1 billion by exchanging unsecured notes to secured second lien notes. This news, however, may also suggest its unit holders will have to face a tax liability for any cancellation of debt. For a company that back in Q3 had a debt-to-equity ratio of 4.57 - and is still likely to present in its upcoming Q4 earnings report a high debt burden - any debt reduction could help at this point. The recent press release appears, at first, as a mixed bag: On the one hand, the company used up its $3.6 billion credit facility. On the other, the management plans to improve its balance sheet.
What can we make out of this news?
Credit facility: LINE already announced back in Q3 that its credit facility was reduced to $3.6 billion. And the company may face additional "borrowing base reductions in certain circumstances". So after taking on this debt, Linn has come closer to be insolvent if the banks were to cut again its credit facility. The management also didn't elaborate on the usage of these funds and only stated: "These funds are intended to be used for general corporate purposes."
Keep in mind, back in 2015 90% of its oil output was hedged at $88, but in 2016 only 70% of its yield is hedged at $90. So the company is facing lower cash flow from its hedges.
In any case, this news could be open for interpretation; it may suggest the cash burning rate hasn't slowed down enough for the company to use its revenue from its operations to cover its costs.
Exploring strategic alternatives: LINE also plans to explore ways to strengthen its balance sheet. The management didn't offer exact details only that:
"…we believe it is prudent to explore opportunities to strengthen our balance sheet and ensure we have adequate financial flexibility to manage through prolonged commodity price headwinds. By proactively undertaking this process now with the help of our advisors, we believe we can implement a comprehensive solution that will position LINN for long-term success".
Basically, the company will aim to slash its debt and sell assets - not an easy task in the current oil market conditions. If the company does plan to reduce its debt again, as it did back in January, it could mean another a taxable event for its unit-holder that they should consider.
To reach that end, the company hired Lazard and Kirkland & Ellis LLP for their financial and legal serviced, respectively. Lazard specializes in mergers & acquisitions but also advises restructurings, capital structure and capital raising. Kirkland & Ellis has represented high profile clients in the past including BP plc (NYSE:BP) in the 2010 Gulf of Mexico oil spill and Volkswagen and its emissions scandal. The firm also advises on restructuring and worked on five of the 16 largest Chapter 11 filings of 2015. Since the firm was known as "the godfather of restructuring" this could indicate that the company is weighing all options including a massive restructuring given the current market conditions and the cash flow problems it may face moving forward. Nonetheless, given the expected operating cash flow in 2016, it still seems unlikely that the company will need to face a possible bankruptcy this year - albeit it's always a possibility now that LINE exhausted its credit facility.
At this stage, Linn Energy remains highly speculative and very risky. Since this news broke, the stock has been trading down in after-hours trading. No wonder, considering this news doesn't vote well for its unit or bond holders. For bondholders this could include additional debt restructuring and haircuts. For unit-holders this could mean perhaps another taxable event and higher chance of the company going bankrupt. So even if oil prices were to start climbing again, LINE's stock isn't going to recover until management comes out with a clear guidance as to what it plans to do next with the company. For more please see: Is This Oil Company Recovering?
Disclosure: I am/we are long LINE, BP.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.