LINN Energy LLC (NASDAQOTH:LINEQ) and LinnCo LLC (UNKNOWN:LNCO.DL) recently surprised investors by suspending their respective distribution and dividend payments. It was a tough decision for the company to make, but one it felt was the right one in the current environment. Here's what LINN's management team had to say on its second-quarter conference call about that suspension, as well as other moves it's making to weather the current storm in the oil market.
1. Here's why we suspended the distribution
LINN Energy CEO Mark Ellis led off the call by say that "after careful consideration" the company has decided to "suspend the payment of LINN'S distribution and LinnCo's dividend at the end of the third quarter 2015 and reserve approximately $450 million in cash from annualized distributions." It's a decision it believes to be in the best long-term interest of all company stakeholders.
Later on during the call, CFO Kolja Rockov gave a bit more color on the suspension:
So if you look at where have we been, just earlier this week we're trading at a 23% yield. So obviously we're not getting much credit for paying the dividend. And when you look across the other side of the fence, you see an opportunity to repurchase your bonds at a very significant discount and earn a rate of return at yield to maturity of 18%, [equating to] a return on investment of over 50%. So we saw an opportunity to really add meaningful shareholder value, and I think it's what we've done.
In other words, because investors didn't think the dividend was safe, the company decided that it wasn't worth paying at the moment, as it wasn't getting credit by the market for the payout. Instead, it will use that cash to enhance the value of the company in other ways, including buying back its deeply discounted bonds.
2. We're taking advantage of the current market uncertainty
Rockov then provided even more detail on that bond repurchase:
[W]e repurchased approximately $599 million of senior notes in privately negotiated transactions for approximately $392 million, representing a discount to par of approximately 35%, a weighted average yield to maturity of 18% and return on investment of greater than 50%. Year-to-date, we have repurchased approximately $783 million of senior notes. We estimate the aggregate senior note repurchases to result in annualized interest cost savings of approximately $54 million. This significant repurchase of our outstanding senior notes demonstrates our proactive commitment to investing our cash resources in the most attractive risk-adjusted return opportunity. We expect this series of transactions, along with potential future repurchases, to add meaningful unitholder value for the long-term.
In other words, LINN is taking advantage of the currently uncertain market to invest its cash in the best opportunities it can find. In this case, the best opportunity it's seeing is to buy back its own bonds. The company would love to continue to buy back its bonds at a discount, because it believes these transactions will create a lot of value over the long term.
3. Our liquidity is just fine
One of the big worries with LINN, and the industry as a whole, is that its liquidity will dry up as banks and investors will refuse to give it money when it needs it the most. At the moment that's not a concern, since it has roughly $1.5 billion in liquidity. However, given where oil prices are right now, the company expects the borrowing capacity on its credit facility to drop later this year. According to CEO Mark Ellis, LINN's "estimate is that impact probably leaves us with a liquidity of around $1 billion" to end the year. However, the company believes this is more than enough money to operate the company, especially after suspending the distribution.
4. We're generating excess cash flow
The other reason it's comfortable with its liquidity is that it's generating a lot of free cash flow right now. "For the second quarter 2015, we had an excess of net cash ... of approximately $71 million, exceeding guidance by approximately $90 million," Rockov said. While he expects that excess to just be $14 million for the third quarter, for the full year he expects the company to generate more than $200 million in cash.
5. The acquisition market has been really slow
One thing LINN Energy has been known for in the past is its growth-by-acquisition model. However, the company hasn't made any acquisitions this year. LINN would love to take advantage of the current environment and use its AcquisitionCo funding. But as Ellis lamented:
And on the acquisition front, it's just been very slow. There've not been a lot of transactions, but we stand ready. [We] have $1 billion of committed capital there, and we can prosecute that if those opportunities materialize. So we stand ready, but I can tell you that the first part of the year here has been very slow.
While it's not burning a hole in LINN's pockets, the company does have a billion-dollar war chest for acquisitions that it would love to put to work. The problem is that there just aren't a lot of compelling assets coming to market right now, as the whole industry is in a wait-and-see mode. But when an opportunity arises, LINN is ready to jump on it.
One thing LINN Energy's management team made clear is that it didn't suspend its distribution and LinnCo's dividend because it's in distress, as it has plenty of liquidity and is generating free cash flow. Instead, the move was made to take advantage of the market to buy back its bonds at a huge discount. Clearly, this is a company that expects to survive the downturn, despite what the market currently thinks about its chances.