By far, 2015 was LINN Energy's (LINE +0.00%) worst year ever. Not only were its unit prices thrashed, down 88% for the year, but the company also first cut and then suspended its distribution. Weakening commodity prices along with a crushing debt load pushed LINN Energy close to the brink.
Yet there's still hope for the company, which lies mainly in the belief that oil and gas prices will begin to recover in 2016. However, it's a real stretch to think prices will return to their previous highs, which is what's required for LINN Energy's unit price to recover beyond its all-time high. The best that LINN Energy investors can hope for is that the company puts itself back on the path toward sustainability.
LINN's top priority in 2016
Last year, LINN Energy made debt reduction its top priority and it had fairly good success. A number of debt repurchases and exchanges reduced its net debt by $1.8 billion. However, with more than $9 billion in debt still on the books, the company has a way to go. Further, the most worrisome chunk of that debt is its revolving credit facility, which at the moment has $4 billion borrowed, when including its term loan:
|
Type of Debt |
Amount Outstanding |
|---|---|
|
Credit facilities |
$3.5 billion |
|
Term koan |
$500 million |
|
Senior notes |
$4 billion |
|
Second lien notes |
$1 billion |
DATA SOURCE: LINN ENERGY LLC.
The problem with this facility is that LINN's banks have the ability to adjust its borrowing capacity based on the value of the company's oil and gas reserves. Falling oil and gas prices have reduced the value of the company's reserves, and LINN's banks in turn reduces its borrowing base capacity from $5.9 billion at the start of 2015 to $4.7 billion this past October. Another big cut in either the spring or fall redetermination period could bring LINN's borrowing base below its outstanding borrowings, leading to a liquidity crisis, because LINN would have a short amount of time before it would be required to repay the difference.
Source: Apache Corporation.
For LINN Energy to survive through the downturn, it must address its credit facility. But it has few options, aside from issuing very expensive second lien debt, seeking a rescue equity injection from a private equity fund, or selling assets at fire-sale prices. Its best hope is that commodity prices begin to rally, which could make one of these options mildly palpable.
Next on the agenda
Once LINN Energy addresses its near-term liquidity and credit concerns, it needs to figure out a new long-term strategy. Its prior strategy of relying on the capital markets to fund acquisitions to drive growth isn't going to work going forward. In fact, the upstream MLP model that the company has championed over the past few years just might be broken beyond repair, which means the company needs a new go-forward strategy.
This wouldn't be the first time the upstream MLP model blew up. Apache (APA 7.71%) and others tried to push this strategy in the early 1980s only to see it explode a few years later, when oil prices crashed. That downturn led Apache and its fellow upstream MLPs to convert back to C-corps and pursue a more traditional approach to oil and gas development. It's a path that LINN Energy might be better off following, given that Apache was able to rise from those ashes and become a top independent oil company.
That said, should LINN decide to remain an upstream MLP, it will have to do things much differently going forward. It can't rely so heavily on debt, and surely not its credit facility, to fund growth. Further, it won't be able to pay out nearly all of its cash flow to investors, and it will need to be 100% hedged years into the future, even if that significantly limits its upside. That conservative approach is the only way for an upstream MLP to operate sustainably, given the cyclicality of commodity prices.
Investor takeaway
LINN Energy investors have two hopes for 2016 -- first, that it will survive the year by addressing its liquidity issues, and second, that it will develop a new business model that puts it on the path to long-term sustainability so that it can better manage through down cycles. If it can do both, then its best years might still lie ahead of it.
