What Should LINN Energy Do With its Prized Asset?

LINN has yet to maximize the potential of its Midland Basin asset, but it's actively weighing options to create immediate value for investors.

Mar 12, 2014 at 11:38AM

Linn Energy Pump Jack

Upstream exploration and production Master Limited Partnership LINN Energy (NASDAQ:LINE), and its financial holding entity Linn Co, LLC (NASDAQ:LNCO) have an important decision to make regarding a prized asset.

The market was disappointed with LINN's results last year. While it reported solid production growth, particularly from its most promising area, a lingering issue remains with the Midland Basin. LINN is hitting the ball out of the park when it comes to its California operations and, for the most part, the Permian Basin. However, a sizable portion of its Permian position lies in the Midland Basin, which LINN has big plans for.

Of all the possible outcomes, LINN advises investors it's mulling over a potential asset trade, outright cash sale, or pursuing an active drilling program and joint venture. Read on to discover where management seems to be leaning.

Disappointed reaction belies strong core performance
On the surface, there wasn't much for the market to be disappointed with in terms of LINN's performance last year. And yet, LINN and Linn Co have sold off since reporting results. All told, LINN's production rose 22.5% to 822 million cubic feet of equivalents per day. The acquisition of Berry Petroleum boosted production, but not overly so. Excluding the contributions from Berry's assets, total production still rose by nearly 21%.

Going forward, investors should expect a greater contribution from Berry's operations, especially in LINN's California position. LINN's average production there grew to 6,000 barrels per day, two-thirds of which were due specifically to Berry's assets. With Berry in tow, LINN expects total production to soon reach 25,000 barrels per day in California.

LINN's most important area of operations for its future is the Permian Basin. While LINN's results there last year were impressive as well, an overhang on the company is what to do with its Midland Basin position, where LINN has some big ideas.

The Midland Basin: Strategic alternatives aplenty
LINN has several options when it comes to the Midland Basin, which the company clearly wants to monetize. This represents a significant asset, as the Midland Basin operation holds 65% of LINN's total Permian Basin production. LINN is weighing whether to trade the position for a different asset, sell the operation for cash, or develop a drilling program.

LINN management seems to like the idea of an asset trade, since an exchange for long-life mature properties would potentially be more immediately accretive for cash available for distribution. That's because LINN isn't yet maximizing the full potential of the Midland Basin, so trading the position for acreage able to produce current cash flow could increase value. Though, it could also mean forfeiting strong future potential for immediate gratification.

An outright sale is a viable option, but is probably a secondary alternative at this time. Selling the asset in its entirety would generate a tax liability, which management wants to avoid. That's why, as far as a divestment is concerned, an exchange seems more likely. LINN would most likely purchase an asset while simultaneously selling some or all of the Midland Basin position. This is known as a 'like-kind' exchange, and is specifically designed to reduce tax liability.

The likeliest scenario: Drill, baby, drill
Of the available options, the best and likeliest seems to be going ahead with a drilling program, under a joint venture. Management considers this to be a compelling opportunity since a lot of the evaluation work has already been done by LINN's technical team. After a thorough analysis last year, LINN is encouraged by the recently drilled horizontal wells and has determined that the position holds the potential for high rates of return. The position holds a predictable level of resources that have lower rates of decline than typical fields. LINN is fully prepared to commence with a drilling program that will involve 10 horizontal wells, which is set to begin in the second quarter.

At the end of the day, LINN is confident in its future, and investors should be as well. The company boosted production organically last year, and will add even more to its production total now that it has the Berry assets in its portfolio. In addition, it has a positive catalyst due to its promising Midland Basin position, where making a strategic decision soon should increase cash flow substantially.

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Bob Ciura owns shares of Linn Co, LLC. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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