March 3, 2014

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CZR dominates the company news today. February blockbuster in Macau.




  • CZR announces $2.2b asset sale to CACQ 
    • 8:30am call: ; pw: 3889366
  • HOT – at  2:15 p.m. Raymond James Institutional Investor Conference
  • HLT – 3:35 pm Citi Global Property CEO Conference

Tuesday, March 4

  • CONEXPO-CON/AGG – Las Vegas thru Friday
  • PEB –  8:50 a.m. Citi Global Property CEO Conference           
  • HST – 9:30 a.m. Citi Global Property CEO Conference
  • SHO – 10:10 a.m. Citi Global Property CEO Conference
  • MAR – 11 a.m. Raymond James Institutional Investor Conference
  • HOT – 2:15 p.m. Raymond James Institutional Investor Conference
  • DRH – 4:15 p.m. Citi Global Property CEO Conference

Wednesday, March 5

  • STAY – 7:30 a.m. Citi Global Property CEO Conference
  • LHO – 9:30 a.m. Citi Global Property CEO Conference
  • RHP – 10:10 a.m. Citi Global Property CEO Conference
  • FCH – 11:30 a.m. Citi Global Property CEO Conference
  • HT – 12:10 p.m. Citi Global Property CEO Conference
  • MAR – Mitsubishi Seattle Consumer Conference
  • BYD – 4Q13 earnings, after market close, 5pm conf call


CZR – The company held the inaugural lighting of The Las Vegas High Roller for media and locals on Friday evening.  The world's largest observation wheel is the centerpiece of the $550 million Linq located on the Las Vegas Strip. The High Roller is scheduled to be open later this year.

Takeaway:  We saw a preview of the High Roller two weeks ago and were impressed its grandeur, brilliantly colored lighting scheme and striking appearance in the Las Vegas skyline.  It should be a draw.

CZR – More restructuring and negative Q4 pre-announcement.  

Takeaway:  Caesars Entertainment sells $2.2b of asset s to Caesars Growth Partners.  Meanwhile, the core business remains awful with Q4 EBITDA now expected to be roughly 10% below consensus.




GGR soared to MOP 38.007 billion (US$ 4.76 billion, HK$ 36.90 billion) in February, up 40.3% YoY.

Takeaway:  So much for worrying about the January "weakness".  YTD, GGR grew 24%.  We would caution that the math suggests march will show a significant deceleration in growth.  April should also look relatively slow.


'Certain' govt won't grant all tables for Cotai projects: Tam Macau Daily Times

Secretary for Economy and Finance Francis Tam Pak Yuen said the government would not grant all gaming tables the casino operators have requested for their new resorts in Cotai – at least until 2022. That hands the problem on to someone else, as the former factory boss is expected to retire from his post within 12 months, after serving as economy secretary since the handover from Portuguese administration in 1999.  Tam said, “We do not rule out that the projects can get all the tables they have requested – namely 500-700 tables each – 10 years later... As you all know there will be no more land zoned for gaming after the completion [of the resorts] in 2016-17.”

Takeaway:  We're not too worried about the table cap.  The casinos should get enough tables.  Tam's commentary can be read to indicate that annualized growth in tables won't exceed 3% - that doesn't mean that in certain years, the number of table games could increase more than 3%.  Limiting new suppply beyond what is planned is a positive.


Saipan Casino Legislation -  Gaming legislation was introduced today in Saipan.  The proposed legislation allows one casino license holder on Saipan and requires $30 million payment upfront and $15 million every year thereafter until the duration of the license.  The license is for 25 years, with the option to extend for another 15 years or a total of 40 years.

Takeaway:  Asia gaming expansion good for LVS, WYNN, Genting, and to a lesser extent, MGM and MPEL.

Atlantic City Visitation – The number of visitors to Atlantic City fell in 2013, dropping to 26.7 million visitor trips last year, down 2 percent from the 27.2 million in 2012 - reflecting the eighth straight year of declines in a resort town that depends on tourists and casino gamblers for its livelihood.  Atlantic City’s visitor numbers peaked at nearly 35 million in 2005 and have declined every year since then.

Takeaway:  While a number of US commercial airlines have announced additional service to AC for beginning later this spring, it's hard to imagine AC posting any meaningful growth in the coming years. 


Hedgeye remains negative on consumer spending and believes in more inflation.  Following  a great call on rising housing prices, the Hedgeye Macro/Financials team is turning decidedly less positive. 

Takeaway:  We’ve found housing prices to be the single most significant factor in driving gaming revenues over the past 20 years in virtually all gaming markets across the US.



  • The softness in New Durable & Capital Goods Orders extends itself in January.  The labor market continues to improve but at a slowing rate. 
  • Durable Goods declined for two consecutive months for the first time since October 2011 as January New Orders declined -1.0% MoM, unable to comp Decembers -5.3% MoM decline
  • The great 2014 capex resurgence narrative remains in a holding pattern as Core Capex Orders growth retraced Decembers MoM decline but posted its first YoY decline in 10 months.
  • Meanwhile, the preponderance of domestic, fundamental macro data continues to suggest slowing growth – a trend the market continues to discount as utilities, bonds, and gold/commodities continue to outperform pro-growth leverage.
  • After last week’s counter-trend move to 4-weeks of steadily deteriorating improvement in the initial claims data, this morning’s data again reflects a deceleration in the rate of improvement in the domestic labor market. 
  • On a seasonally-adjusted basis, initial jobless claims rose 14k to 348k from 334k WoW, as the prior week's number was unrevised lower by 2K. Meanwhile, the 4-week rolling average of seasonally-adjusted claims was flat WoW at 338K.

Takeaway:  Macro teaming up with demographics and bad weather as headwinds against US gaming.


TODAY’S S&P 500 SET-UP – March 3, 2014

As we look at today's setup for the S&P 500, the range is 36 points or 1.85% downside to 1825 and 0.08% upside to 1861.                           










THE HEDGEYE DAILY OUTLOOK - 10                                                                                                                                                                  



  • YIELD CURVE: 2.30 from 2.33
  • VIX closed at 14 1 day percent change of -0.28%

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Personal Income, Jan., est. 0.2% (prior 0.0%)
  • 8:30am: Personal Spending, Jan., est. 0.1% (prior 0.4%)
  • 8:58am: Markit U.S. PMI Final, Feb., est. 56.7
  • 10am: ISM Manufacturing, Feb., est. 52 (prior 51.3)
  • 10am: Construction Spending m/m, Jan., est. -0.5% (prior 0.1%)


    • U.S. government to close D.C. offices on weather. Events may be delayed or postponed.
    • Obama urges Netanyahu to make Mideast peace now
    • Xi seeks terrorism crackdown after deadly China knife attack
    • N. Korea fires 2 short-range missiles off E. Coast: South
    • 8:30am: Netanyahu, Senate Foreign Relations Cmte Chairman Robert Menendez deliver remarks during morning session of American Israeli Political Action Cmte policy conf.
    • 11am: House Ways and Means Chairman Dave Camp attends briefing on tax code changes hosted by Institute for Policy Innovation
    • 3:30pm Energy Dept holds FY 2015 budget briefing
    • Obama, Netanyahu meet to discuss Israeli-Palestinian peace talks, Iran


  • Kerry heads to Ukraine as U.S. considering Russia sanctions
  • PepsiCo, Gazprom face sales threat on Ukraine standoff
  • Putin grab for Crimea shows trail of signs West ignored
  • Ukraine tension seen stoking energy costs on supply concern
  • Riverbed said to get buyout interest above Elliott’s offer
  • Banks’ corporate-bond sales said to face SEC favoritism probe
  • Google, Samsung said to express MSFT-Nokia concern to China
  • J. Crew said to hold sale talks with Fast Retailing
  • Uniqlo billionaire push for global crown fuels J. Crew talks
  • Buffett sets fresh goal as Berkshire misses 5-yr target
  • Roche to halt MetMab lung cancer trial after study failure
  • Obama said to trim budget request for struggling CFTC
  • Sbarro said to ready bankruptcy filing as mall traffic slows
  • Mexico said to question Citi workers in Oceanografia probe
  • Home Depot’s new president said to be groomed as CEO successor
  • Microsoft’s Nadella said to shake up staff with Penn role
  • Gap plans to expand in China w/up to 35 new stores: WSJ
  • Tablet sales rise 68% in 2013, Apple mkt share falls: Gartner
  • EPA said poised to lower U.S. sulfur limits on fuel
  • HSBC China Feb. manufacturing PMI 48.5, matching estimate
  • Macau casino rev. jumps to record after Chinese new year
  • Neeson’s ‘Non-Stop’ tops Lego film for N.A. box office lead
  • ‘12 Years a Slave’ Wins Academy Award for 2013 Best Picture
  • Winter storm missing New York set to bring worst to Washington
  • Feb. U.S. auto sales: Chrysler ~8am, Ford ~9:30am, GM ~10am


    • Akorn (AKRX) 6am, $0.14
    • Celldex Therapeutics (CLDX) 8:03am, ($0.28)
    • Rockwood Holdings (ROC) 6:30am, $0.32
    • Stillwater Mining Co (SWC) 8am, $0.06
    • Stratasys (SSYS) 6:30am, $0.49
    • WP Carey (WPC) 8am, $0.57


    • Ascena Retail Group (ASNA) 4:02pm, $0.21
    • AuRico Gold (AUQ CN) 4:37pm, break-even
    • Guidewire Software (GWRE) 4:01pm, $0.02
    • MBIA (MBI) 4:01pm, $0.17
    • McDermott International (MDR) 4:10pm, $0.16
    • PDL BioPharma (PDLI) 4:02pm, $0.41
    • URS (URS) 4:05pm, $0.18


  • Commodities Climb to Six-Month High as Oil, Corn Rise on Ukraine
  • Brent Crude Surges as Ukraine Tension Escalates; WTI Advances
  • Hedge Funds Most Bullish on Gold Rally in 14 Months: Commodities
  • Copper Reaches Three-Month Low as Manufacturing Slows in China
  • Palm Oil Export Growth Stalling in Indonesia on Biodiesel Surge
  • Gold Climbs to Four-Month High as Ukraine Tension Boosts Demand
  • Sugar Falls as Delivery Seen Showing ‘Dire’ Demand; Coffee Rises
  • Wheat Advances With Corn as Ukraine Crisis Threatens Shipments
  • Rebar in Shanghai Rises as Chinese Lawmakers Meet on Policies
  • U.S. Natural Gas Rises a Second Day on Storm, Ukraine Escalation
  • Ukraine Tension Seen Stoking Oil, Gas Prices on Supply Risk
  • Gold Miners See Looming Output Drop After Cut in Spending
  • Oil at $100 Loss Warning Rejected by Norges Bank: Nordic Credit
  • Iron Ore Supply May Increase 50% by 2018, Model Shows


























The Hedgeye Macro Team















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Detached From Reality

“They have a detached-from-reality, academic, floating abstraction form of intelligence.”

-John Allison


While I was flying to LA last night (during the Oscars, because that’s how I roll), that is not a quote about Hollywood. That’s what the former CEO of one of the best banks in American #history said about the Fed’s finest.


That free markets would make better price decisions than elitist central planners (members of the Federal Reserve) should not be a surprise. Ludwig von Mises proved the futility of central planning in his numerous books, including The Theory of Money and Credit (1913), Socialism (1922), and Human Action (1940).” (The Financial Crisis And The Free Market Cure, pg 34)


If you haven’t objectively studied any of those four books, no worries. Bush, Obama, Bernanke, and Yellen haven’t either.


But you can watch the real-world economics of currencies burning the purchasing power of their peoples this morning in Crimea. I’m hearing that with the Ukrainian currency crashing (-21% YTD), the Ukraine’s stock market being up +43.9% YTD (in burning FX terms) is bullish.


Detached From Reality - yellow


Back to the Global Macro Grind


In Burning Bucks, the US Stock market was “up for 2014” too – for like 1.5 days. But, after US GDP almost getting cut in half sequentially, and some geopolitical risk pin-action in equity futures today, that will change. Life that is detached from reality generally does, in a hurry.


My inbox is jammed. I can’t count how many emails I received on Friday saying that the “market is up on a GDP slowdown – your research call feels right, but the market doesn’t care”, or something like that…


To be clear, I don’t go with the how markets and GDP “feel” thing. You can overpay to get that from someone else. While the SP500 was up a whopping +0.6% for 2014 YTD (it’s March fyi), it's mainly the inflation and #GrowthSlowing parts of the market leading that:

  1. Healthcare (XLV) = +7.2%
  2. Utilities (XLU) = +6.5%
  3. Basic Materials = +1.9%

The most meaningful parts of the economic cycle (the consumption economy) are actually down YTD:

  1. Consumer Staples (XLP) = -1.5%
  2. Financials (XLF) = -0.7%
  3. Industrials (XLI) = -0.4%

But no worries, as long as you aren’t long anything like Kinder Morgan (KMI, KMP, KMR) in Bernanke’s overvalued Yield Chasing space – or short anything that loves US #Stagflation (like Gold +11.4% YTD), you’re killing it with the whole “market is up” thing.


In other non-Crimean news, US GDP #GrowthSlowing sequentially (from 4.12% in Q313 to 2.37% in Q413) is only the beginning of the Down Dollar (USD down another -0.7% last wk, and down 3 of the last 4 weeks), Down Rates (UST 10yr Yield -38bps YTD) thing.


And, looking at the components of the US GDP report:

  1. The Deflator (made-up inflation rate) bounce, big time, off its almost 50 yr low
  2. Government Spending dropped -1.05% sequentially from a GDP contribution perspective

So, the key vectors in the P (Policy) piece of the Hedgeye GIP (Growth, inflation, Policy) model are going to require the US government to:

  1. MONETARY vector – have the Fed start telling you we need a Policy To Inflate in order to amplify “inequality”
  2. FISCAL vector – have Obama ramp up deficit spending again in order to pretend to slow the “inequality”

I know, both US monetary and fiscal policy going dovish on the margin is just fantastic. Because, without going to sub 2% US GDP growth and plus 2% made-up-reported-inflation growth, how the heck else could the Keynesians blame Russia?


I’m actually hearing from my contacts in Miami that the Mexicans are going to blame the Russians too. Instead of ripping on US GDP #GrowthSlowing on Friday, Mexico’s stock market dropped to -2.4% on the wk to -9.2% YTD.


Yep, life in Latin America is starting to suck. With the whole deficit-spending-debt-ramp thing, Venezuela and Argentina are reminding people that Latin American stock markets can go down on stagflation too (MSCI LATAM Index -0.1% last wk to -8.1% YTD).


So cheer up – the “market is up.” Away from food and energy prices ripping humanity another new one last week:

  1. CRB Foodstuffs Index +3.2% to +10.5% YTD
  2. Oats (I’m probably just a rich guy eating the stuff) +7.1% to +42.2% YTD
  3. Coffee up another +6.4% w/w to + 59.6% YTD

There’s not a lot to worry about re: the whole #InflationAccelerating thing either… Unless you aren’t detached from reality, of course.


Our immediate-term Risk Ranges are now as follows (our Top 12 macro ranges are in our Daily Trading Range product):



VIX 13.28-16.99

USD 79.59-80.31

EUR/USD 1.36-1.38


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Detached From Reality - G7 VIX


Detached From Reality - virt55

LINN Energy: The Short Case Is as Strong as Ever

If it wasn’t for companies like LINN Energy (LINE, LNCO), this job wouldn’t be any fun…  We’ve had SHORT LNCO on our Best Ideas List since 3/21/13 ($38.60/share), and it’s been quite the roller coaster.  But considering where LINN is today, we believe that the short case is as strong as it’s ever been.  We reiterate our negative view, and fair value price of ~$9 - $10/unit (~70% downside).


First off, LINN is still the subject of an SEC inquiry that is at least focused on LINN’s “use of non-GAAP financial measures and disclosures related to [its] hedging strategy” (LINE 2013 10-K pg. 117).  We have written ad nauseum about both of these issues; while there’s no telling what the SEC will or won’t do, nearly all of LINE’s DCF would be instantly erased should the SEC require a realistic representation of LINN’s maintenance CapEx.  That risk cannot be ignored, though we’re not counting on it happening and we don’t have to – LINN’s fundamental outlook is bleak enough.


The Berry Petroleum (BRY) merger has closed and LINN is now bigger, slower-growth, more oil-weighted, and with a significantly higher full-cycle cost structure.  The deal – which was supposed to be immediately accretive to “DCF” and actually isn’t – has failed to help LINN much at all, in our view.  What it did do was expose a higher % of LINN’s cash flows to a steeply-backwardated WTI curve, which likely will be a problem; and create 94MM new LINE units (increasing the unit count by 40%) that each get a $2.90 annual distribution (for now).


LINN will be around free cash flow neutral in 2014 with zero-to-LSD organic production growth (it is also possible that LINN’s organic production growth goes negative this year).  The entire distribution, ~$960MM in 2014, will be funded with new debt and equity capital.  LINN had $9.1B of net debt as of YE13, and will have ~$10.0B at YE14 (~4.7x our 2014 EBITDA estimate) absent an equity raise.  LINN’s organic production growth is stalling and its materially-understated (~$800MM/year by our estimates) maintenance CapEx is becoming more of an obvious and ridiculous issue. 


Since announcing the BRY deal, California crude differentials have collapsed and natural gas prices have increased, squeezing cash margins on the acquired assets.  LINN is now net short natural gas!  NGL prices spiked in January and February, led by propane, but have already begun to come off and should continue to trend lower through at least the spring and summer; LINN’s 2014 NGL price guidance is aggressive, in our view.


LINN has told anyone that will listen how transformational a sale/swap of its Wolfberry/Wolfcamp assets will be; the sell-side seems (easily) convinced, and we’ve had several conversations with buy-siders that inform us how wrong we are on LINN because this asset has “changed the game.”  The optimism is overwhelming, and a lot of it is already priced in.  However, most don’t seem to realize that LINN is going to have to monetize PDP reserves (i.e. cash flow) at a significant discount to where LINN’s equity is currently trading.  Will the undeveloped acreage command a price high enough to make the entire sale/swap accretive?  We think that it’s going to be tougher than most believe...  And with respect to LINN’s credibility in valuing non-producing assets, know that LINN has written off ~900 Bcfe of PUD reserves over the last three years.  Disappointing results in the once-highly-touted Granite Wash/Hogshooter play led to an $800MM impairment charge this year alone (pretty amazing that this imminent write-down was not disclosed in the LINN/BRY S-4, right?).  In our opinion, the Permian sale/swap is just another tree for the bulls to stare at; a convenient distraction from the weak operational and financial results, which we discuss below.




On the 4Q13 Results……First, we debunk the alleged “beat.”  Reported DCF came in at $202MM vs. $171MM guide, +$31MM.  $14MM, or 45% of the “beat”, was from “adjustments to the purchase prices of acquisitions,” which is, in our view, highly aggressive to include in DCF (see our previous work on LINN for more on this adjustment) and was not in the guidance.  Second, a contribution from BRY was not included the guidance, but contributed to LINN’s results for 15 days given the Dec. 16th close.  BRY generates ~$2MM/day of EBITDA, so we’ll estimate that BRY contributed $30MM of EBITDA to the Q.  Maintenance CapEx above the guide was $12MM, add $3MM of interest expense, and we get a ~$15MM DCF contribution from BRY to LINN’s 4Q13 results, and that was not in the guidance.  So really, there was no material DCF beat. 


Production ex. BRY for the Q came in at 845 MMcfe/d, below the midpoint of guidance (840 – 860 MMcfe/d).  Natural gas production was particularly weak, coming in at 441 MMcf/d (including BRY) vs. guidance of 447 – 460 MMcf/d (excluding BRY).  Underperformance in the Mid-Con and Hugoton Field (weather issues?) were the likely culprits.  Expect Mid-Con production to continue to decline (and at a faster clip) in 2014 as LINN moves from 8 rigs in the Granite Wash to 4 rigs by mid-year.  LINN will only spend ~$170MM in the Granite Wash in 2014, versus ~$600MM in 2012 and $600MM in 2013.


Clean EBITDAX in 4Q13 was $377mm, missing consensus by 10% ($423mm per Bloomberg).  Open (ex. derivatives) EBITDAX was $319mm.  Clean net income was +$0.15/unit; excluding the impact of derivatives, LINN lost $0.09 in the quarter.  Consensus was looking for EPU of +$0.26.  On an clean/open basis, LINN lost $0.16/unit in 2013.  LINN does not generate profits from producing oil and gas.


Total CapEx (E&P + Plant + JV) increased $46MM QoQ to $385MM in 4Q13; E&P CapEx was $310MM, up $39MM QoQ.  Discretionary Cash Flow (CFFO before changes in WC) was flat QoQ at $299MM (before a deduction for premiums paid on settled derivatives).


Free cash flow (gasp!) was negative $86MM in 4Q; deducting another $43MM for the cost basis of settled derivatives in the period (our estimate, LINN no longer discloses it) gets us to a true FCF deficit of $129MM in 4Q13.  For the full year, FCF was negative $202MM, and negative $374MM including the cost basis of settled derivatives (we estimate it to be $172MM).  See the table below:


 LINN Energy: The Short Case Is as Strong as Ever - linn cash 2


LINN will be around FCF neutral in 2014, so the entire ~$960MM of distributions will be financed with new debt and equity capital.  Net debt at YE13 was $9.1B – it will climb to ~$10.0B by YE14 assuming no equity raise.  By our estimates, LINN’s debt-to-EBITDA ratio will be ~4.7x at YE14.  LINN does not have a debt-to-EBITDA covenant ratio, but management has stated before that it’s comfortable ~3.0 – 3.5x.  LINN is not in jeopardy of tripping any leverage covenants, but its debt will increase by ~$225MM/Q! as long as it continues to pay the current distribution.  Every distribution paid dilutes the enterprise value by an equivalent amount.     




2013 Organic F&D Results......In our view, the “Reserve Replacement Metrics” that LINN published on page 12 of its 2/27/13 Investor Presentation are misleading, because LINN compares drill bit capital expenditures with changes in total reserves, rather than just developed reserves.  Specifically, their “cost-to-add per Mcfe” metric is flat wrong.  Of the 527 Bcfe of “extensions, discoveries, and other additions,” 390 Bcfe (74%) of them were proved undeveloped reserves (PUDs) (that will probably get revised lower at some point in the future, given the trend)!  When analyzing F&D results, one needs to compare drill bit capital employed to the organic change in proved developed reserves; this is where the rubber meets the road – turning capital into production and cash flow, not PUDs.


In 2013, LINN’s Drill Bit PD F&D cost was $3.19/Mcfe (this is the REAL “cost-to-add”), and reserve replacement was 122%.  The trend over the last three years has not been good – F&D costs are trending higher and reserve replacement is trending lower.  Going forward, we expect LINN’s F&D costs to continue to trend higher as it employs capital into BRY’s capital-intensive, oil-weighted asset base.  See the table below for a summary of LINN’s organic PD F&D and reserve replacement metrics from 2011 - 2013:


LINN Energy: The Short Case Is as Strong as Ever - linn2 




LINN’s Maintenance CapEx Guidance is Nonsensical……We just don’t know what else to say about this – it’s a complete joke.  Let’s try and make sense of the 2014 guidance...  1Q14 production is guided to 1,070 – 1,100 MMcfe/d and full-year 2014 production is 1,070 – 1,140 MMcfe/d. 


 LINN Energy: The Short Case Is as Strong as Ever - linn prod guide


The guidance implies virtually no production growth (indeed, 0% at the low end of the range) as we move through 2014, yet the total CapEx guidance of $1.6B is DOUBLE the maintenance CapEx guidance of $802MM???  So LINN will spend ~$400MM/Q to keep production about flat on a sequential basis, but tells us that maintenance CapEx is ~$200MM/Q…  How does that work?  If we think about this rationally, LINN’s ENITRE capex budget (and perhaps more) is maintenance.  If we were to include that amount in LINN’s 2014 DCF guidance, DCF falls to $0.49/unit (-83%).  What yield target should we put on that?  How about 10%?  $4.90/unit stock price…


Another way to think about maintenance capex is the cost of replacing produced reserves. 


As calculated in the prior table, LINN’s PD F&D was $3.19/Mcfe in 2013.  However, BRY’s asset base is significantly more capital intensive than legacy LINN’s; BRY’s drill bit PD F&D cost was $5.90/Mcfe ($36/boe) on average in 2011 and 2012 (see Table below).  We estimate (with incomplete information) that BRY’s 2013 PD F&D cost was ~$5.00/Mcfe (~20MM boe of organic additions with costs incurred of $600MM).  We expect LINN’s drill bit F&D cost to increase significantly in 2014 as it employs capital into BRY’s California and Uinta heavy/waxy crude properties.  LINN will produce ~400 Bcfe in 2014.  Assuming an F&D of $4.00/Mcfe ($24/boe) in 2014, it would cost LINN $1.6B to replace produced reserves.  This F&D assumption could be too low, which would mean that LINN’s guided $1.6B total CapEx budget will not be enough to replace produce reserves/keep production flat over the course of 2014 (wire-to-wire, Jan 1 to Dec 31).


LINN Energy: The Short Case Is as Strong as Ever - linn4




The 2016 Revenue Cliff……By our calculations, assuming flat production and strip commodity prices, LINN’s revenues in 2016 will drop by $272MM from 2014, which is 28% of LINN’s 2014 nominal DCF guidance.  The issue worsens from there – by 2018 LINN’s oil and natural gas revenues will be $521MM below 2014, 54% of guided 2014 DCF.  See the table below:   


 LINN Energy: The Short Case Is as Strong as Ever - linn5


LINN has ~120 Bcf of natural gas swapped in 2016 at ~$1.00/Mcf lower than it is in 2014 and 2015, so that’s a $120MM revenue hit there.  And then LINN only has 60% of its crude hedged in 2015 and 2016, and the existing hedges are all above the current strip prices.  LINN’s management is a talking out of both sides of its mouth when it tell investors that it likes to hedge 100% of production for five years, but won’t go out and swap the BRY oil volumes, because doing so would lock in the revenue decline.   


How is LINN going to dig itself out of this one?


The only legitimate hope is a big rally in oil and NGL futures, because LINN has ~100% of its natural gas production hedged through 2017.  By our estimate, the 2016 WTI swap has to move from the current price of $84 to over $105 for oil and gas revenues to be flat with 2014.


Absent a material step-change higher in WTI futures, LINN is in trouble and will have to get creative... 


Does LINN start playing games with the hedge book again?  Maybe buy some in the money puts?  Maybe pay cash to increase that 2016 natural gas swap price?  It wouldn't surprise us – here’s the disclosure to justify something like that:


“Although it is the Company’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” (LINE 2013 10-K, pg. 64).




On the Potential Permian Sale/Swap……LINN is working to monetize its Midland Basin Permian assets in some form, and plow the proceeds back into shallower-decline, mature, producing properties; this is the new flavor-of-the-month bull case that LINN supporters have clung to, as nearly every other aspect of this story has disappointed.  But is it really that great of an idea?


First off, it is important to know that LINN is really selling two different assets here: PDP reserves (i.e. cash flow), primarily from a vertical Wolfberry program started in 2010, currently producing 17,000 boe/d with an average first-year decline of 35%; and 55,000 net undeveloped acres with Hz. Wolfcamp potential (no current cash flow). 


LINN has expensive equity (~8.9x EV/2014 Open EBITDA; $104,000 EV/boe/d) because it financially-engineers an out-sized distribution, which investors value the equity off of.   With LINN’s equity trading at a significant premium to its NAV, is it really a good idea for LINN to sell producing assets?  Perhaps, but only if the price LINN gets for the undeveloped acreage exceeds the dilution created by selling the PDP reserves at NAV.


So what's the PDP asset worth?  We know it’s currently producing 17,000 boe/d, the first-year average decline is 35%, and it’s primarily vertical Wolfberry wells.  That’s enough information for us to be dangerous.  Using strip prices, we estimate that the asset will generate $247MM of open EBITDA in 2014 and $156MM of open EBITDA in 2015; the big YoY drop is due to the steep production decline and backwardated commodity curves.  The net present value of this cash flow stream (we have it cash-flowing through 2045) at a 10% discount rate is $820MM.  That’s our net asset value (NAV), and around what we think LINN could sell it for.


The NAV of $820MM works out to 3.3x 2014 EBITDA and $48,000/boe/d of current production.  With LINE currently trading at ~8.9x EV/Open EBITDA and $104,000/boe/d, it has a large hole to fill with the sale of the undeveloped acreage in order to make this deal accretive.  On a 2014 EV/EBITDA basis, we estimate that LINN has to sell the 55,000 net acres for ~$25,000/acre to prevent dilution (this is the math in the table below).  On an EV/boe/d basis, LINN has to sell that acreage for ~$17,000/acre to prevent dilution.


We don’t know what LINN will get for this package in a sale or swap.  It’s broken up into eight packages across several different counties, and the range of comparable transaction metrics is wide (~$5k/acre - $35k/acre).  Consensus seems to be around $15k - $25k/acre.  The point that we are making here is that consensus is likely to be disappointed, whatever the number ends up being, because most are not considering the dilutive sale of the PDPs.


LINN Energy: The Short Case Is as Strong as Ever - permian value 




Updated LINE Valuation……We value LINN using a sum-of-the-parts NAV, as well as on an EV/EBITDA basis.  Our LINE fair value is ~$9 - $10/unit, and believe that LNCO should trade at a discount to LINE given the future tax liability.  In our LINE NAV calculation, we value LINN’s proved reserves at 90% of the YE13 SEC Standardized Measure given the steeply backwardated oil curve not reflected in that metric, and LINN’s history of consistently writing down proved reserves (917 Bcfe of negative performance and timing revisions over the last 3 years; $1.3B of impairment charges over the last two years).  We value LINN’s entire Hz. Wolfcamp acreage at $18,000/acre – really a best guess and in-line with consensus.  Our target EV/EBITDA multiple is 5.0x 2014, a slight premium to the average multiple of similarly slow growth, large cap, North American E&Ps: APA, APC, COP, DNR, DVN, OXY, SU, and WLL (4.8x on average). We are probably being too generous to LINN here – LINN’s outsized leverage, below-peer organic growth, ongoing SEC inquiry, and questionable accounting and hedging strategy likely more than make up for LINN’s tax-exempt status as an MLP.  See the table below:


LINN Energy: The Short Case Is as Strong as Ever - linn value 




Miscellaneous Points

  • The California crude price – an important one to LINN now – is back to a discount to WTI.  When LINN announced the BRY deal in February 2013, California crude was trading at a ~$12/bbl premium to WTI.  On an annual basis, BRY produces 7 – 8 MMbbls of California crude.  The differential collapsing from +$12/bbl to the current -$1/bbl is a ~$100MM hit to annual revenues (and EBITDA, DCF, etc.).

 LINN Energy: The Short Case Is as Strong as Ever - cali crude

  • LINN is guiding its NGL price to $40/bbl in January, February, and for the full-year 2014.  This doesn’t make sense.  The NGL barrel (propane in particular) spiked in January and February on a temporary shortage, and has already traded off hard to a price below the 4Q13 average.  The Mont Belvieu propane forward curve for the rest of 2014 is ~$1.05/gal, versus the spike to ~$1.40 – $1.70/gal in January/February.  LINN’s realized NGL price in 4Q13 was $32/bbl – with the propane forward curve where it is, it’s hard for us to believe that LINN's realized NGL price will be much higher than that in 2Q14 – 4Q14…  This commentary from LINN’s CFO Kolja Rockov on the 2/27/14 conference call is baffling:

I would also like to take a moment to discuss the recent increase we've seen in NGL prices. The current composite price of NGLs at Mont Belvieu has increased approximately 11% since the end of the third quarter 2013. This is primarily due to colder than normal weather and increased exports. In particular, propane has been strong, in part due to the continued demand from liquid propane gas, or LPG exports and residential heating. Propane prices have increased approximately 21% and 18% at Mont Belvieu and Conway respectively during the same time. Our NGL production remains unhedged and the continuation of this trend is expected to be very positive to our future financial results.”


 LINN Energy: The Short Case Is as Strong as Ever - propane

  • A couple other points on management’s credibility...  First, LINN suggested late last year that the BRY deal would be immediately accretive to the distribution – now, it is not, as the 2014 guidance shows.  Second, LINN’s base decline at YE13 was in the “mid 20’s” (i.e. ~25%) including BRY…  We were under the impression that legacy LINN’s base decline was ~25%, and that it would immediately drop to ~18% with the acquisition of BRY.  Guess not.   
  • Interesting disclosure from the LINN 2013 10-K with respect to LINN, Tallgrass (TEP) and Kinder Morgan (KMI and EPB): "In connection with the Berry acquisition, the Company assumed certain firm transportation contracts on interstate and intrastate pipelines entered into by Berry to assure the delivery of its natural gas to market. These commitments generally require a minimum monthly charge regardless of whether the contracted capacity is used or not. Currently, the Company's natural gas production is insufficient to fully utilize its contracted capacity on the Rockies Express, Wyoming Interstate and Ruby pipelines" 
  • The cash flow statement looks a little better than it should because LINN acquired $451MM of cash from BRY and netted it against the acquisition line in CFFI.  There's nothing wrong with that, but worth knowing when thinking about how the cash moved in and out of LINN's doors in 2013.  


Kevin Kaiser

Managing Director


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