How LINN Is Protecting Its Huge Payout

LINN Energy and LinnCo are increasing the lifespan of their assets to keep the distribution safe.

Jul 12, 2014 at 8:54AM

LINN Energy LLC (NASDAQ:LINE) recently announced that it will acquire natural gas-weighted assets from Devon Energy for $2.3 billion. Devon will shed its non-core assets so it can focus more on liquids-rich areas as LINN Energy expands its low decline production base to safeguard its distribution in the future. To Devon, the divested assets didn't fit in with its long-term plan, but for LINN Energy and its sister company LinnCo LLC (NASDAQ:LNCO), these assets are perfect. 

The two recent deals LINN and LinnCo made shifted the production mix toward natural gas, but this comes on the heels of its very oil-weighted acquisition of Berry Petroleum. LINN is repositioning its asset portfolio so that it's weighted heavily toward low decline wells, which may annoy Wall Street in the short term but will be greatly appreciated in the long term. To get an idea of why these assets are perfect for LINN Energy and LinnCo, investors should first take a look at LINN's recent asset swap.

Funding the distribution
When LINN Energy traded part of its position in the Permian Basin to ExxonMobil, some questioned why LINN would trade away premium acreage for miles and miles of natural gas-weighted acreage in the Hugoton Field. What those investors missed was that developing the Permian Basin, while profitable, is very capital intensive. It would take years of development and tons of cash for that asset to generate free cash flow, which would take away from LINN Energy's distribution, and LinnCo's dividend. 

Before the asset swap, LINN Energy's distribution coverage ratio was 0.993, meaning that LINN would pay out more than it was taking in this year. If LINN were to have spent the extra cash developing its horizontal Permian position, it would have exacerbated the payout funding problem. On top of that, shale wells have first-year production decline rates around 60%-80%, which means LINN would only be raking in distributable cash flow for a short period of time unless it purchased and developed more acreage.

Investing in LINN Energy and LinnCo isn't about growth; it's all about income, which is why LINN Energy and LinnCo pay out 8.9% and 9.3% yields, respectively. After the asset swap, LINN Energy and LinnCo's payouts are now fully funded, relieving investors of the worry that the distribution or dividend would be cut. On top of fully funding its distribution, LINN will now be able to use its new asset from Devon to grow production and payouts in the future. Low decline wells, combined with organic and acqusition generated production growth, will safeguard the distribution for years to come. 

Safeguarding future payouts through organic growth and cost synergies
When the deal with Devon is completed in the third quarter of this year, LINN will add 275 MMcfe/d, or million cubic feet equivalent a day, of output (80% gas) to its estimated 2014 production of 1,100 MMcfe/d. A low production decline rate of 14% will enable LINN to slowly grow output by developing the 1,000 future drilling locations, and 600 recompletion opportunities, on its new 900,000 net acre position. As production increases, the additional cash flow will be transferred to investors due to the low capital intensity of developing this asset. 

Beyond production growth, LINN will also realize substantial cost savings due to most of the new acreage overlapping with its existing holdings, providing logistical synergies. In the asset swap deal with Exxon, LINN will also be able to realize cost savings through overlapping acreage, as it could feed more natural gas into its Jayhawk gas plant. In 2013, the approximately 3,880 active wells on this acreage generated $350 million in EBITDA for Devon, earnings that will now go toward LINN and LinnCo's payout. As costs trend lower while output slow increases, investors will start to truly appreciate the income opportunities from conventional wells.

While funding this purchase will require the sale of its Granite Wash assets, those assets should fetch a high price, as LINN Energy has successfully found 17 hydrocarbon-producing intervals on its 147,000 net acres in Oklahoma and the Texas Panhandle. While the production mix is liquids rich, the first year decline rate averages around ~40%. By selling off this asset, LINN will lose 230 MMcfe/d of liquids-rich natural gas production, but the distributable cash flow will be replaced through the Exxon asset swap, the Devon acquisition, cost savings, organic production growth, and new, low-decline assets that LINN will be able to acquire. 

Foolish conclusion
LINN Energy and LinnCo are in it for the long run. For most E&P players, liquids-rich shale plays are the best locations to deploy capital, but LINN isn't like most E&P companies. Shale plays require plenty of time and capital to bring enough production online to generate free cash flow, while low decline conventional assets are already generating free cash flow (distributable cash flow for an MLP). With production decline rates and maintenance costs low, conventional assets will keep pumping out free cash flow for years to come, making LINN Energy and LinnCo's recent deals ideal for income oriented investors.

Combined with the cost savings from its overlapping acreage and existing infrastructure, LINN's recent deal making will more than cover its already high payout, providing room for income growth. Backed by long lasting, low decline assets with plenty of opportunities for organic growth, LINN Energy and LinnCo are two of the best income plays in the energy sector.

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That’s beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor’s portfolio. To see our free report on these stocks, just click here now.

Callum Turcan owns shares of LinnCo. The Motley Fool owns shares of Devon Energy. 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.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.


Compare Brokers