Robust and growing distributions are the measuring stick of success for master limited partnerships, so when upstream MLP Linn Energy announced in early January that it would cut its distribution by a whopping 57% in response to free-falling oil prices, it must have been desperate or insane, right? For years, we’ve watched the MLPs do everything possible to boost the distribution to woo yield-oriented investors, and to go down in yield even a little was considered the proverbial third rail—sure death in the marketplace.
Now Linn has firmly grasped that rail, the first (certainly not last) upstream MLP to do so. And maybe, just maybe, this is an aggressive, offensive strategic positioning rather than a defensive move as some perceive.
Raymond James analyst Kevin Smith sees it that way. While other analysts are either downgrading Linn or holding neutral, Smith boldly reiterated an Outperform rating in a Feb. 6 research note, citing various moves Linn is making to position itself for acquisitions.
“With Linn’s deep hedge book, expectation to be cash-flow neutral in 2015, and over $2 billion in untapped liquidity, in our view Linn is in an attractive position to take advantage of this period of weak oil and gas prices to opportunistically purchase assets—and possibly companies,” he said.
Beside the distribution cut, other moves have shored up Linn’s financial strength to be poised for acquisitions as others flounder.
Simultaneous to the distribution cut, Linn, like most other producers, slashed its 2015 capital program by more than half of its prior-year expenditures. This cut allows it to maintain current production levels while being cash-flow neutral, “something its peers are going to struggle to do.”
Not so exciting in its singularity, but on top of that the Houston-based MLP joined with private-equity player GSO Capital Partners to fund its growth-oriented drilling program to the tune of $500 million—without any additional capital expenditure by Linn.
Add to that a robust hedge book to shore up cash flow, and the company is poised to pounce. Acquisitions are likely, according to Smith. Big acquisitions. Recall that Linn has done this before, with the $4.6-billion buyout of oil-rich Berry Petroleum.
“Due to the 50% decline in oil prices over the last seven months, we expect to see a tremendous amount of oil and gas properties on the market in the second half of the year as companies aggressively pare down debt levels … Look for Linn to be an active acquirer in 2015.”
In addition to the GSO pact, Linn is seeking another private capital alliance for acquisition funding.
This, said Smith, would give Linn the flexibility to bid on assets heretofore not considered MLP-friendly, allowing the to-be-determined partnership to split the assets by long-lived producing vs. valuable drilling inventory. Linn could conceivably retain a first option to buy any non-MLP-friendly assets once their production levels out.
Additionally, with its stock price bouncing 30% since its January low following the distribution announcement, Smith believes Linn will aggressively pursue a C-corp acquisition “due to the fact that Linn needs to use equity-financed acquisitions to help the company reduce its financial leverage,” Smith said. “In addition to the property market, we expect Linn to aggressively use its LNCO paper to try and acquire an E&P corporation.”
Oil-weighted assets are likely targets, he said, due to the contango of the price pullback, as are certain basins that are now less attractive from an organic growth outlook due to reduced market valuation for PUD and undeveloped acreage. “Therefore, for the first time, Bakken producers are a likely target,” he said. “We anticipate that it is more likely for Bakken asset deals to get done in this environment, given the relatively unattractive drilling economics of the basin.”
So who could be on the hit list, ponders Smith?
“We think likely targets are Rockies producers Northern Oil and Gas, Oasis Petroleum and Bill Barrett. Given Linn’s market cap of $4.1 billion, we would expect Linn to target companies with market caps between $1 billion and $2 billion.”
A broader list of maybes, all small-cap, E&P C-corps, includes Bonanza Creek, Clayton Williams, Comstock Resources, Laredo Petroleum, Resolute Energy, Rosetta Resources, SandRidge Energy and Ultra Petroleum.
So the pullback in distribution and capex are merely preparation for opportunity ahead, believes Smith. To think Linn won’t be bigger and stronger on the other side of the trough is just insanity.
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