Takeaway.....Better-than-expected 3Q13 on the DCF side, but with a massive outspend relative to maintenance CapEx (again); 4Q13 organic production guided down; outcome of the SEC Inquiry / BRY merger remains a big question; we make the case for LINE fair value at $5.00 / unit; no change in our view, LINE / LNCO remains a top short idea.
3Q13 DCF Beats, Production In Line……LINN’s 3Q13 Distributable Cash Flow (even though LINN doesn’t use the term anymore, it’s still what some people care about) came in at $173MM vs. $148MM guided. Stronger-than-expected oil production volumes and lower cash costs drove the beat. LINN reported volumes of 823 MMcfe/d vs. guidance of 810 – 830 MMcfe/d and 780 MMcfe/d in 2Q13 (up 5.5% QoQ). Oil production beat the high end of the guidance range, likely due to a ramp in activity and spending in the Granite Wash and Anadarko JV over the last two quarters. Production taxes came in $11.5MM below guidance, as ad valorem taxes, “which are based on the value of reserves and production equipment” fell “primarily due to lower assessed values on the Company’s base properties” (3Q13 10-Q). Is that bullish? Adjusted, Open Net Income came in at $0.12/unit and open EBITDA was $334MM
4Q13 Organic Production Guided Down……LINN left its 4Q13 production guidance flat at 850 MMcfe/d (assuming no ethane rejection) from its prior guidance, despite the fact that it will have a material contribution from the newly-acquired Permian Basin assets, which was not factored into the previous guide. The deal is expected to close “on or before October 31, 2013” (3Q13 10-Q). LINN expects the asset to average 4,800 boe/d (63% oil) over the first 12 months, which would amount to a ~19 MMcfe/d contribution in 4Q13. This makes the acquisition all the more interesting because it looks like it was done just to plug a hole. LINN increased 4Q13 DCF guidance by ~$9MM, but by our math that incremental DCF is all from these acquired, high-margin oil properties.
Huge CapEx Burn (Again)……LINN spent $339MM in total organic CapEx in the quarter, with only $116MM held back from distributions as “discretionary reductions for a portion of oil and natural gas development costs.” (This was formerly known as “maintenance capital expenditures;” despite the change in terminology, nothing has changed with how this number is calculated.) Total CapEx exceeded maintenance CapEx by $223MM in the Q, more than the $171MM distribution payment. Over the TTM, total CapEx exceeds maintenance CapEx by ~$900MM, while production was ~+1.6% YoY on an organic basis, by our calculations. Just shocking…
2013 CapEx Guidance is Too Low……Excluding acquisitions, YTD 2013 CapEx is $959MM (per the CF statement); the 2013 guidance remains at $1,150MM (3Q13 10-Q), implying that LINN will spend less than $200MM in CapEx in 4Q13. We find that highly unlikely considering that CapEx was ~$340MM/quarter over the past two quarters. FY13 CapEx is likely to be closer to $1,300MM.
Free Cash Flow Negative……Over the TTM, LINN has paid out $682MM in distributions on a similar amount of what was previously called DCF, all the while being sharply Free Cash Flow (FCF) negative, before acquisitions. In 3Q13, FCF was -$84MM; over the TTM FCF was -$388MM. For a Company that doesn’t grow organically, and pays out massive distributions, this is concerning.
Premiums Paid Disclosure Disappears......It is disappointing that LINN has removed disclosure telling investors what the premiums paid for derivatives that settled in the period were. It was disclosed in the 2Q13 10-Q as $43MM (~28% of DCF). In our view, this is the amount by which LINN's DCF is overstated due to its aggressive derivatives accounting methodology, and is important information that needs to be disclosed.
An argument for LINE at $5.00/unit……LINN is now trading around 8.9x Adjusted EV / Open EBITDA (we annualized the 3Q13 open EBITDA number and adjusted the EV lower by the net derivative asset per the 3Q13 balance sheet). On this measure, of the large cap E&Ps, only EQT, COG, PXD, and RRC are more expensive, and these companies have arguably the best undeveloped acreage positions and future growth potential of all NAm E&Ps. Consider that SU, DVN, OXY, APC, and DNR all trade around 5 – 6x 3Q13e Annualized EBITDA. What is LINN Energy? A free cash flow negative E&P with no organic growth, no shale scale, no material non-proven value (midstream or acreage), and highly-dubious accounting practices which are currently the focus of an SEC inquiry. For perspective, LINN at 5.0x EBITDA is a ~$5.00/unit stock. This isn't to say it's going there (at least any time soon), but we are tired of hearing the "LINN is cheap" argument. In our view, LINN is over-valued by at least 100%.
Kevin Kaiser
Managing Director
