This morning (10/22) LINN Energy filed the 5th Ammendment to its Form S-4 Registration Statement for the LINE / LNCO / BRY merger. For the second time, LINN changes verbiage and disclosure, but not distributions. The market is taking these changes to be quite positive (LINE +2% at the time of writing), though it's not clear to us why...
The key change in this version is that LINN will no longer use the non-GAAP measure "Adjusted EBITDA." In fact, it has removed substantial disclosure and reconciliations related to “Adjusted EBITDA,” “Credit Facility EBITDA,” and “EBITDA” in the latest S-4/A. This comes after removing "Distributable Cash Flow (DCF)" in the S-4/A #4. The market's positive reaction to this latest change could suggest that investors believe that LINN has done enough to satisfy the SEC, as the SEC was concerned with LINN's use of non-GAAP measures, and LINN has solved the problem by no longer using them... We have no view as to what the SEC will or will not do, though the optimism seems excessive, in our view.
With Adjusted EBITDA and DCF out of the picture, the key non-GAAP measure that remains is what was formerly known as "maintenance capital expenditures," but is now "discretionary reductions for a portion of oil and natural gas development costs." Importantly, "This change in terminology, however, does not reflect any change in LINN’s methodology for determining the amount of these costs" (pg. 233); in other words, nothing has changed except for what LINN is calling it; same as the prior S-4/A.
LINN did include new data for the amount of reserves estimated to be converted to the PDP status via discretionary reductions CapEx (pg. 236 and cut out below):
The F&D (finding and developing) cost for this capital is remarkably low compared to LINN's consolidated metrics. For instance, discretionary reductions F&D was $1.37/Mcfe in 2012, 36% below the PUD Conversion Cost and 64% below LINN's organic (ex. acquisition) proved developed F&D cost. LINN's numbers imply that it's non-"discretionary reductions" capital had a staggeringly-high F&D cost of $13.85/Mcfe in 2012 ($886MM to move 64 Bcfe into the PD category).
How anyone can take these numbers seriously, we don't know. LINN's total PD F&D cost over the last three years is $3.41/Mcfe ($20.46/boe). Based on that number, at current production levels, LINN needs to spend at least $250MM/quarter to keep reserve and production flat, not the ~$110MM/quarter it's currently calling "discretionary reductions." Of course, LINN's distribution would be cut by ~100% should it deduct that amount of capital from the cash available for distribution - hence its reluctance to change.
Other Notable Changes in the 10/22 S-4/A (#5):
- Page 50: Change in wording for the “discretionary reductions” risk factor. Dropped terms "natural decline," "cash production," and swapped "producing assets" our for "producing reserves."
- Page 171 on the “remedial method”: “Additionally, the pro forma financial information does not represent the actual results of allocating depreciation, depletion and amortization and other cost recovery deductions generated from the “remedial allocation method” pursuant to Treasury Regulation Section 1.704-3(d). The total tax liability generated from the remedial allocation will be recognized over the remaining life of the underlying assets, which could extend beyond 50 years. See footnote (d) to LinnCo’s notes to the unaudited pro forma condensed combined financial statements for additional information.”
- Page 210: David Hall vs. Berry Petroleum Company – “parties are currently engaged in settlement discussions” was removed.
- Page 233-4: Significant changes in wording / disclosure re: distribution calculation; and no longer using “Adjusted EBITDA.”
- Page 235: LINN clarifies funding, “LINN intends to fund interest expense, a portion of its oil and natural gas development costs and distributions to unitholders from net cash provided by operating activities. LINN funds premiums paid for derivatives, acquisitions and other capital expenditures primarily with proceeds from debt or equity offerings, borrowings under its Amended Credit Facility or other external sources of funding. Although it is LINN’s practice to acquire or modify derivative instruments with external sources of funding, any cash settlements on derivatives are reported as operating cash flows and may be used to fund distributions.”
- Page 235 footnote 1: LINN acknowledges that even through premiums paid hit the GAAP cash flow statement as CFFO, it considers them investments, so it will add them back to operating cash flow to arrive at cash available for distribution.
Kevin Kaiser
Senior Analyst