The Best Next Move for LINN Energy

LINN Energy should make an effort to buy a privately held C-Corp with LinnCo.

Matthew DiLallo
Matthew DiLallo
Apr 21, 2014 at 1:00PM
Energy, Materials, and Utilities

Photo credit: LINN Energy.

LINN Energy (NASDAQOTH:LINEQ) and LinnCo (UNKNOWN:LNCO.DL) have a long road of recovery ahead to regain the market's favor. The company's balance sheet could use some work, and it needs to do a better job at consistently growing its production and distribution. But while most investors are focusing on company's exploration of strategic alternatives for its Midland Basin acreage, that might not be the best next move for LINN Energy.

The LinnCo retirement plan
Instead, I think the company should use LinnCo to buy a privately held C-Corp as its next move. After basically overpaying to close its acquisition of Berry Petroleum, LINN needs another equity-financed acquisition that offsets some of that dilution. The best way to get that done without paying a high market premium to entice shareholders to sign off on a deal is to use LinnCo as an exit strategy for the owners of a closely held energy company.


Photo credit: LINN Energy

LINN should look for an ownership group that is seeking to exit day-to-day operations but still wants to profit from what it has built over a lifetime. A LinnCo-led deal would accomplish that, while also enabling the exiting group to avoid paying major taxes on a sale -- the deal could be structured like the tax-free share exchange that worked in the Berry acquisition. The deal would provide instant liquidity to the sellers, as well as an income stream for retirement. It's really an ideal exit.

LINN could negotiate a fair price for the assets, but might not need to pay too steep a price thanks to the added benefits of a LinnCo-led transaction.The right fit would involve a a company loaded with low-decline, cash-gushing assets that would be an immediately accretive fit within the LINN Energy portfolio. Furthermore, by doing an all-equity deal, LINN could improve both its leverage ratio and its distribution coverage ratio.

Buying time
Such a deal would buy the company time so that it can truly maximize the value of its Midland Basin acreage, which analysts say could be worth over $2 billion. As the following slide shows, the company has divided its acreage into eight distinct geographical packages.

Source: LINN Energy Investor Presentation (Link opens a PDF).

Having more time would allow LINN Energy to complete its planned 10-well horizontal program in the Midland Basin this year. While those well results could disappoint, there's just as much potential for an upside surprise, which could increase the value of LINN's acreage in the Midland Basin. LINN could spend the money to do the scientific work necessary to better prove its acreage, which would increase the value of what it is looking to sell. 

Investor takeaway
While most LINN Energy investors want the company to complete a deal for its Midland Basin acres right away, that might not be the best next move for the company. A better move would be to find a really great privately held oil company to acquire in a LinnCo-led retirement plan. LinnCo could offer the sellers greater value due to its tax advantages, which could enable LINN to get a good deal. Such a deal would improve LINN's credit and cash flow metrics so that it can take its time as it works to maximize the value of the Midland Basin assets.