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Is This Blueprint from the Past LINN Energy LLC's Only Hope for Survival?

By Matthew DiLallo - Mar 14, 2016 at 12:05PM

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The upstream MLP is reportedly considering a structural change that’s very similar to the one taken by Apache a couple of decades ago.


Image Source: LINN Energy LLC

According to a recent report by the Wall Street JournalLINN Energy (LINEQ) is exploring a major change to its corporate structure. Such a move would not only prevent the company from restructuring via bankruptcy, but it would also shield investors from a major tax hit that would result from having some of its debt forgiven. It's an interesting blueprint, if for no other reason than it's similar to the one followed by upstream MLPs the last time the oil market imploded.

What LINN Energy might do
Given its lofty debt levels, LINN Energy is exploring a variety of options in order to keep the company afloat amid the worst oil downturn in several decades. Up until recently the company had taken a bit of a piecemeal approach to addressing its debt, with the company engaging in a variety of exchanges with credit investors to reduce the company's debt burden. It has made some headway, reducing its total outstanding debt by roughly $1.8 billion, however, with $9 billion of debt left to restructure, the company still has a long road ahead of it.

That's why it has hired advisors to look at taking a broader approach to restructuring its debt, with the company seeking debt forgiveness outside of bankruptcy. While such a move would enable the company to live to fight another day, it would also create a big tax hit for investors. It's a hit the company would like to avoid, given the beating investors have already taken over the past year. That's where an old blueprint from former upstream MLP leader Apache (APA 2.06%) is coming into play, which was the one it used during the last big oil bust.

The Apache blueprint
In the early 1980s Apache was a trailblazer for a new investment vehicle that was intended to benefit investors. That vehicle was the creation of the first publicly traded master limited partnership, Apache Petroleum Company, which took advantage of relatively high oil prices and the tax law to provide investors with an opportunity to enjoy the liquidity and price appreciation of a stock alongside the tax advantages of a partnership. It was a model that worked until oil prices went bust and the tax laws changed. By 1987 Apache abandoned the vehicle it helped champion by offering investors the opportunity to exchange their units for shares of its C-Corp, Apache Corporation, or a newly created entity called Key Production Company.

Image Source: Apache Corporation.

It's a blueprint that LINN Energy is increasingly likely to follow in order to avoid going bankrupt. Under such a scenario LINN Energy would merge its MLP into the company's affiliated C-Corp, which already owns a substantial number of LINN Energy's outstanding units. The exchange would result in all investors owning stock in the C-Corp instead of units of an MLP and thus shield them from the tax hit they'd incur if debt forgiveness was part of the company's restructuring plan.

Such a change would also likely dramatically alter the way LINN Energy operates in the future once a sense of normalcy returns to the oil market. Long gone will be the days of growing by acquisition and paying out high distributions, instead, the company would likely follow the path of a more traditional exploration and production company, such as the way Apache operates today. It would seek to grow its production organically and use internally generated cash flow to fund this growth with any leftover cash potentially being used to pay dividends instead of distributions. In other words, LINN Energy would become like every other oil and gas company, though one that, at least initially, would be focused on owning and operating conventional oil and gas wells as opposed to focusing on shale like most of its peers are doing right now.

Investor takeaway
While LINN Energy has a limited amount of options, it does at least have options that could keep the company from going bankrupt. The one that appears the most likely would be to follow the blueprint of Apache and merge the company with its affiliated C-Corp. This would both avoid a big tax hit to its partners as well as provide a path to a new way forward. It just might be the company's only viable path forward given the damage that has been done to the company over the past year. 

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