Back in October, Linn Energy (NASDAQOTH: LINEQ ) launched an initial public offering of its Linn Co (NASDAQOTH: LNCOQ ) subsidiary. The vision behind Linn Co according to CEO Mark Ellis was to "develop a simple way to turn a K1 distribution into a 1099 cash dividend and significantly broaden our access to capital." Management saw this transaction as a game changer, as it would create an additional option for institutional and retail shareholders to invest in the growth of Linn.
Distributions, dividends and taxes
Linn's not the first energy company to seek to raise capital through an innovative new way to invest in the company. Midstream giant Kinder Morgan (NYSE: KMI ) is known for its four ways that investors can profit from the company's business, including it's pipeline and storage operator Kinder Morgan Energy Partners (NYSE: KMP ) . Both Linn and Kinder Morgan require a steady supply of new capital to keep growing, and these investment vehicles help to reach a broad range of investors.
The draw of the business models of both Kinder Morgan Energy Partners and Linn Energy are the hefty income streams that each throws off. Because of the tax-efficient structure, both distribute very generous cash flows back to investors. However, these distributions come with a catch, extra paperwork in the form of an annual Schedule K-1. Unfortunately that paperwork is a deterrent for many investors which then limits both company's access to capital.
The ownership structure and thesis behind the transaction is pretty straight forward as according to Linn's CFO Kolja Rockov:
Linn Co's sole purpose is to own Linn units, and shareholders will see the cash dividend in Form 1099 instead of a distribution and scheduled K-1. This should allow investors which are averse to owning MLPs a better way to invest in Linn. Linn Co will offer its shareholders equivalent voting rights and participation in any distribution growth, which Linn Energy unit holders currently receive.
If you own shares of Linn Co its just like owning units of Linn Energy, just without the extra paperwork.
The IPO recap
Linn Co's $1.3 billion IPO was a real landmark deal for the company, and for the markets, as it was the second largest IPO of 2012. Demand from institutions was strong with $2 billion of institutional orders placed and a key for Linn is that 83% of those orders represented new investors in the company. The offering was also met with record-breaking retail demand of $1.7 billion. Because of the strong demand and aftermarket trading performance the underwriters exercised the full overallotment option on the first day. All of this bodes well for future market demand for Linn Co stock and the company's ability to use it to raise additional capital.
How Linn Co fits into Linn's future
In the decade since Linn Energy went public it's acquired $10 billion worth of mature oil and gas assets in 54 separate deals. The Linn Co deal provides the company with a vehicle to accelerate its acquisition growth strategy as management sees a very robust acquisition environment over the next 12-18 months.
Over the past year, Linn acquired $2.8 billion in assets, including two separate deals with BP. In the second deal, the Jonah Field in Wyoming was acquired for $1.025 billion. Linn closed the deal by funding it entirely through its revolver; however, that was subsequently refinanced by the Linn Co IPO proceeds. That transaction should give investors insight on how Linn is likely to operate going forward.
What's the future hold?
The onshore drilling renaissance in the U.S. is creating a unique opportunity for Linn Energy. As companies focus on higher growth shale plays, many are seeking to sell off more mature producing properties. Many of these drillers have embarked on ambitious and expensive capital programs to grow production, but high debt loads and low natural gas prices have made balance sheets tight across the industry. Increasingly, companies are selling more mature assets to pay for these ambitious growth plans.
A recent example of this was SandRidge Energy's (NYSE: SD ) sale of its Permian Basin operations to a privately held energy company for $2.6 billion. With an already heavy debt load, SandRidge needed the cash to fund its drilling operations in the high growth Mississippi Lime play. By selling its Permian Basin operations, SandRidge is now able to fully fund its capital plans through 2014.
SandRidge is just one of a number of exploration and production companies in the industry with stretched balance sheets that will benefit from selling off mature oil and gas assets. Linn has the capacity to take advantage of an increasing number of these opportunities that hit the market now that Linn Co is public. These deals add to Linn's cash flow which is increasingly being returned back to investors. These are exciting times for investors in Linn.
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