Drilling Down into Linn Energy: Which Linn is Right for You?

By Matthew DiLallo - October 21, 2012 | Tickers: CHK, EPD, XOM, LNCO, LINE | 0 Comments

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With the recent IPO of Linn Energy (NASDAQ: LINE) subsidiary LinnCo (NASDAQ: LNCO), energy investors now have a choice in how to invest in this exceptional operator.  Do you want large quarterly distributions with an equally large headache from a Schedule K-1 to deal with each year come tax time?  Or would you take a slightly smaller quarterly payout in exchange for the ease of a 1099?  Before you can answer those questions, you need to answer the question of whether Linn is a good investment for you to consider in the first place. 

The Linn Story

Linn is “a different kind of oil and natural gas company” whose mission is to “acquire, develop and maximize the cash flow from a growing portfolio of long-life oil and natural gas assets.”    This now $15 billion company by enterprise value has a large 5.1 Tcfe total proved reserve base which is 45% oil and NGLs and 55% natural gas.  They have more than 15,000 gross producing wells in six core operating areas with a 21 year reserve life.

This growth-by-acquisition company has made 54 acquisitions by deploying nearly $10 billion worth of capital over the past decade.  These are mature assets that produce significant current cash flows, which they lock in via a 100% hedge program that typically extends out four to six years.   Additionally, Linn has organic drilling upside from thousands of low risk development opportunities on the acres they acquire. 

This locked in cash flow has enabled Linn to pay a growing distribution to their unit holders.  Currently that works out to $2.90 a unit, which is good for a 7% yield.  The company has grown that distribution by 81% over the past six years.  Linn is a stable, cash gushing energy company that is more of a yield play with solid upside from their organic growth prospects.  Summed up, I think that they'll beat the market over the long term with much less volatility.

Why Invest in Linn Energy LLC?

If you want to invest directly in the business I just described and plan to hold the units in a regular brokerage account, then Linn Energy LLC might be for you.  If you’re already familiar in investing in an MLP type company, like Enterprise Products Partners (NYSE: EPD) for example, then you’re already familiar with the pumped up distributions and Schedule K-1’s.  What’s nice about Linn is that, like Enterprise, they don’t have the General Partner with Incentive Distribution Rights that a typical MLP will have.  This means more cash flows directly to unit holders. 

The difference between these two is that Linn owns wells that produce the gas, oil and NGL’s while Enterprise and their peers own the pipelines and processing plants that get the gas from the wells to the market.  An MLP is a tax advantaged structure enabling more of the profits to flow to owners as opposed to the pockets of Uncle Sam.   If you want some energy exposure with an excellent payout in your non-retirement account, and don’t mind the K-1’s come tax time, then Linn Energy LLC is the one for you.

Why Invest in LinnCo?

If you like the Linn story but only have a retirement account then you’d choose LinnCo as your investment vehicle.  This newly public company eliminates the tax burden associated with a Schedule K-1 by issuing a 1099 instead, making it ideal for your IRA.  There would be no state income taxes and generally no Unrelated Business Taxable Income, so you could also own it in a brokerage account as well. 

While Linn Energy LLC unit holders would enjoy that $2.90 quarterly distribution, those at LinnCo would have to settle for slightly less.  Current estimates have them paying about $0.015 a share in taxes each quarter, meaning shareholders would net $2.84 over the course of a year.  With shares trading at a discount to Linn’s that works out to a slightly higher yield of 7.4%. 

You’d own LinnCo if you are accustomed to owning an integrated oil giant like Exxon Mobil (NYSE: XOM) or a gas producer like Chesapeake Energy (NYSE: CHK) in your IRA.  You’d consider swapping out your Exxon or Chesapeake stake if earning income in that IRA is more of a priority for you. 

Exxon currently only pays a 2.5% quarterly dividend, meaning it would take you three years to earn the same income as you would with LinnCo.  Chesapeake investors and their paltry 1.7% dividend would need four and a half years to earn what they’d receive with LinnCo.  Some might prefer the diversity of Exxon’s global business or the upside found in Chesapeake’s highly levered gas business, however, if you’re looking for a stable income producer for your retirement years then LinnCo is worth your consideration.

A final and potentially more important factor to consider is the hedge program of Linn.  They are 100% hedged from commodity price volatility through 2016.  Most C-Corp peers are just 66% hedged this year, 47% next, with virtually no hedges in 2016.   Compare this to Chesapeake which has hedged 64% of their natural gas production this year and none next year.  Hedging cuts both ways as it protects when prices fall but drags when they are rising. With Linn, stability with a touch of upside is the name of the game.

Bottom Line

I think Linn is an exceptional way to invest in energy.  Now investors have the option of investing in LinnCo with their IRA or Linn in a regular brokerage account.  No matter how you choose to invest in Linn, the large, growing and secure quarterly payments are hard to beat in today’s low yield environment. 

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