Guilty until proven innocent

After the market closed on July 1st, LINN Energy which trades under the stock ticker (LINE), announced that it had been notified by the staff of the Securities and Exchange Commission (SEC) that a private, non-public inquiry into the company had begun.  The SEC has requested the preservation of documents and communications that are potentially relevant to, among other things, LinnCo’s proposed merger with Berry Petroleum Company, and LINN and LinnCo’s use of non-GAAP financial measures and hedging strategy.  The SEC has stated that the fact of the inquiry should not be construed as an indication that the SEC or its staff has a negative view of any entity, individual or security. LINN and LinnCo are cooperating fully with the SEC in this matter.

LINN is a Master Limited Partnership (MLP) in the energy exploration and production (E&P) space.  MLP’s have been popular with investors due to their high dividend yield and dividend growth profile.  LINN Energy’s mission is to acquire, develop and maximize cash flow from a growing portfolio of long-life oil and natural gas assets. LINN Energy is a top-15 U.S. independent oil and natural gas development company, with approximately 4.8 Tcfe of proved reserves in producing U.S. basins as of December 31, 2012.

While the SEC has yet to disclose any wrong-doing, LINN shareholders are voting with their feet sending shares from $33 to under $23:

Here are some facts to give investors pause both before and after the SEC investigation:

·        * E&P stock generally pay dividends in the 3% area vs. 12.60% for LINN today.  How can this company in the same sector distribute yields in double digit territory?

·        * LINE consistently reports lower metrics in terms of ROE, ROA and operating margins among other metrics relative to its peer group.  How is it then that LINN can earn less yet pay out more than other companies in the sector?

·        * LINN has benefited from hedges, but hedges cost money and ultimately roll off or require additional funds to keep them in place.

·        * How can LINN acquire additional assets for growth in operations and dividends when debt already represents 153% of equity and totals $6.190 billion?

·        * With the stock in the low $20’s, any issuance of stock for future acquisitions will prove highly dilutive to existing shareholders.

·       *  LINN has a low and declining reserve base.

        Many MLP’s report a metric known as Distributable Cash Flow (DCF) which reflects the cash available for distribution to shareholders.  Analysts are concerned that DCF is manipulated in highly questionable ways by MLPs very much the same way that net earnings are manipulated in questionable ways by C-Corps.  The SEC is investigating LINE’s failure to account for its hedging expenses when calculating DCF.  Apparently, LINE management felt that the massive amounts of shareholder value expended via derivatives transactions to hedge oil and natural gas prices was not relevant to the accounting of DCF.

        LINE and many other MLPs essentially disguise depleting asset bases by using greater fool acquisition strategies and by creative accounting of both Maintenance CapEx estimates and acquisition expenses.  This enables these MLPs to continue to make large and even growing payouts even as the fundamentally based instinsic value of the company is deteriorating.

        As the old adage goes, if it sounds too good to be true, it probably is.  At$33, prior to the decline in its stock price, LINN yielded 8.78% and now at $23 the yield has surged to 12.60%.  Compare that to the 10 year Treasury yield which is now at a new high for the move of the past few months at 2.74%.  See my prior blog ‘Hey! Where are you going with that punch bowl?’ ( which warns of rising interest rates.  Absent a clean bill of health from the SEC, I would avoid the temptation of the higher dividend yield LINE offers.  If you’d like accounting based clarity and insights into your specific equity holdings and the market in general, please contact me at Christine Meder’s Accounting Advisory Services to schedule a free 30 minute consultation or tweet me at @christinemeder1.  #unrbrand


About Christine Meder
Leveraging my insights and professional experience of 25 years in the accounting profession, I and my firm Christine Meder's Accounting Advisory Services provide our high net worth clients expert advice on their business activities and investments. In addition to performing traditional accounting functions in a confidential manner, I pride myself in giving clients a competitive edge whether it be in running their businesses or managing their investment portfolio. My studies leading up to completion of the EMBA program at the University of Nevada, Reno this August provide me with latest skills and techniques utilized across a broad spectrum of business functions. This breadth of education is complemented with experience as an accountant in the construction, mining, real estate and technology fields during my career. If you are looking for a trusted adviser or consultant in addition to someone you can rely on to properly keep your books, please contact me.

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