No Regrets on Linn Energy
In last week’s Energy Letter, I reviewed our decision last September to purge the refiners from The Energy Strategist’s portfolios. Today I want to revisit another call from the past: Our 2013 decision to recommend the sale of Linn Energy (NASDAQ: LINE).
Linn Energy is a master limited partnership that has specialized in acquiring mature, long-lived oil and gas wells and using hedges to minimize the commodity price risk. Its hedging strategy made it very popular with investors, because it helped drive a narrative that Linn was largely protected against a drop in oil prices. This also helped ease investors’ concerns about tthe partnership’s high debt levels.
Last week, all that leverage finally proved too much and all those hedges not enough, as Linn filed for Chapter 11 bankruptcy protection. The company reported $8.3 billion in debt and under the plan submitted to the court, its shareholders will lose everything. After trading as high as $40 per unit just a few years ago, Linn closed at 12 cents last Friday.
We were criticized for that particular Sell call quite a bit at the time, either for not making it sooner or for making it at all. Allow me to provide a bit of color about what was going on at that time.
During the first half of 2013 we felt that most of the concerns being raised about Linn’s financial reporting were overblown. Nevertheless, these concerns were on our radar, and we particularly flagged the debt as an item to watch. Igor and I discussed Linn several times, and decided to stick with it.
That is until the partnership revealed a Securities and Exchange Commission (SEC) inquiry about its use of non-GAAP accounting and hedging strategy. We were concerned that even in the best case, the SEC inquiry would drag on for months and weigh on the unit price. In the worst case, the SEC would find evidence of wrongdoing. So on July 2, 2013 we issued the following alert to subscribers:
We’re downgrading Linn Energy (NSDQ: LINE) to SELL after the partnership today announced an informal Securities and Exchange Commission probe of its accounting. The probe endangers Linn’s pending acquisition of Berry Petroleum (NYSE: BRY), the linchpin of its growth strategy.
Factoring today’s drop, LINE units have provided total returns of 73.6%, 113.4% and 102.1%, respectively in the Personal Finance, MLP Profits and The Energy Strategist portfolios. But now that the SEC has, at least for the time being, legitimized recent complaints about Linn’s financials, cashing out is the most prudent course of action. Sell Linn Energy.
The closing price on the day of our Sell alert was $27.05/unit. Linn had traded mostly around $38 in the months leading up to the announcement of the SEC inquiry, so some readers were unhappy that we hadn’t gotten out earlier. Of course it’s always hard to top-tick a security. Stocks are usually sold after something goes wrong with the prior bullish thesis, something that has already begun to be reflected in the share price.
Others criticized us for not sticking with Linn. After all, they argued, the SEC inquiry was likely to find nothing and this could represent a chance to buy at a discount. (There were numerous articles making that case following news of the SEC probe.) Indeed, in early 2015 the SEC closed its investigation after finding no evidence of wrongdoing. But by then, it was already clear to us that a combination of falling oil prices and heavy debt levels couldn’t be overcome by Linn’s hedges. And in fact we purged MLP Profits and Energy Strategist portfolios of virtually all upstream MLPs that year well before they began their precipitous decline.
Since we made that Sell call, two of the most common questions I have fielded from investors have been 1) “I didn’t sell Linn when you issued the sell alert, so should I do so now?” and 2) “Is it time to get back into Linn?”
We consistently gave the same answers. We never again recommended the company to investors. Of course we wish we would have bailed out sooner than we did, but in hindsight we are certainly glad that we didn’t wait until the more serious problems clearly manifested themselves.
What ultimately brought Linn down wasn’t the SEC inquiry, but the collapse in oil and gas prices that has proven to be so detrimental to the entire upstream MLP space. The upstream MLP business model works well as long as oil prices are high, but even with hedges the falling oil prices of the past two years made it impossible for upstream MLPs to finance their distributions. And in the case of Linn Energy even continue to fund their business proved a stretch. (Update: Fellow upstream MLP Breitburn Energy Partners also filed for Chapter 11 bankruptcy this week,)