Oil prices have remained a lot weaker for a lot longer than most oil companies had ever expected. This persistent weakness is causing a lot of uncertainty, which is forcing weaker oil companies like LINN Energy (LINEQ) and affiliate LinnCo (NASDAQ: LNCO) to take action to address their issues before it's too late. We saw that last week when the companies exchanged $2 billion of debt in a deal that reduced both interest expenses and outstanding debt. While it's a big step forward, it might not be the last debt reduction initiative taken on by the company.
Details on the debt deal
Under the terms of this latest debt transaction, LINN Energy is exchanging $2 billion worth of its unsecured notes for $1 billion of new second lien notes. In a sense, the exchange wipes $1 billion in debt from its balance sheet. That said, it does come at a high price, with LINN Energy's new notes coming with a 12% interest rate. That's well above the 8.625% rate of the highest-yielding notes that were part of the exchange. However, even with that higher rate, the company will decrease its annualized interest expense by $16 million.
Overall, LINN Energy is exchanging portions of five tranches of its notes for these new second lien notes, which are due in 2020. Here's what the exchange looks like:
|
Unsecured Notes Exchanged |
Par Value of |
Principal Amount |
|---|---|---|
|
6.50% senior notes due May 2019 |
$584 |
$292 |
|
6.25% senior notes due November 2019 |
$824 |
$412 |
|
8.625% senior notes due April 2020 |
$286 |
$143 |
|
7.75% senior notes due February 2021 |
$184 |
$92 |
|
6.50% senior notes due September 2021 |
$121 |
$61 |
|
Total |
$2,000 |
$1,000 |
Data source: LINN Energy LLC. Dollars in millions.
The exchange provides three important benefits to LINN and LinnCo:
- It reduces the total leverage by $1 billion.
- It reduces annual interest expenses by $16 million.
- It reduces the nearest debt maturity in 2019 by $1.4 billion.
What's next for LINN Energy?
With this latest exchange, LINN Energy has now repurchased or exchanged nearly $2.8 billion of its senior notes for $557 million in cash and another $1 billion of new notes. That's a $1.8 billion net reduction of debt. Furthermore, it has reduced its cash interest expenses by $70 million annually. That said, the company still has $9 billion in debt that would need to be addressed if oil remains at its current level for a few more years.
However, what's most important to note here is the fact that the $9 billion number isn't the biggest concern for LINN and LinnCo. Instead, the types of outstanding debt are what need to be addressed. Here's a look at its pro forma debt structure:
|
Type of Debt |
Amount Outstanding |
|---|---|
|
Credit Facilities |
$3.5 Billion |
|
Term Loan |
$500 Million |
|
Senior Notes |
$4 Billion |
|
Second Lien Notes |
$1 Billion |
Data source: LINN Energy LLC.
The biggest issues are the credit facilities and term loan, which started the year with $5.9 billion of total combined borrowing capacity. However, for the second time this year, the borrowing base was redetermined by LINN Energy's banks with this latest redetermination resulting in another reduction in the combined borrowing base, this time down to $4.7 billion. That leaves the company with just $790 million in liquidity for the next six months, at which time LINN's banks will engage in another redetermination. The implication here is that this spare capacity could again be chipped away in the spring if oil prices remain weak.
The worst-case scenario here would be for LINN's borrowing base to be redetermined below its outstanding borrowings. Such a result would force the company to scramble for cash to pay back the difference. So, in order to avoid such a scenario LINN needs to "do something" to address its credit facility before next spring. The good news here is that the company does have a range of options including selling non-core, limited production assets such as its Northern Louisiana or Mid-Continent development plays, acquiring a financially stronger company, or seeking out a cash infusion from private equity.
Investor takeaway
LINN Energy and LinnCo are making clear progress on balance sheet improvements. That said, more work needs to be done, especially to reduce the amount borrowed on the credit facilities. The good news is LINN has both the time and options to address this problem. The bad news is that investors can expect this stock to be very volatile until either oil prices vastly improve or it's back on sound financial footing. Because of this, LINN Energy's future continues to remain very binary, with substantial upside if prices improve but an outside chance of going under if prices remain weak and it doesn't address its debt issues in time.
