Linn Energy - The Brouhaha Edition (Working Version)

A certain Keith McCullough and Jim Cramer recently got into a very public brouhaha over Linn Energy LLC (“LINE”) and LinnCo LLC (“LNCO”). I personally enjoy these battleground stocks very much (in part, because I’ve demonstrated the ability to make money off some of them) and wanted to post my initial thoughts. I may update this post periodically, and keep it as a ‘working version’ document indefinitely.

You should assume this post is for educational, conversational, and entertainment purposes. Below, I include reasons to:

(A) Buy/Hold

(B) Sell/Short and

(C) Open Questions and Thoughts

A few disclosures:

  1. I currently hold no position in LINE, LNCO.
  2. I am currently short another name in the same or similar space(s).
  3. I have not spoken privately with Jim Cramer, Keith McCullough, or any other bull/bear about LINE/LNCO for the purposes of this post.
  4. This post is subject to change and revision, at my full discretion, at any time.
  5. 1, 2, 3, and 4 may change at any time.

Reasons to Buy/Hold:

  1. High short interest (as a shorter duration risk factor) and/or perceived high high short interest.
  2. High dividend yield (From a behavioral/decision-science perspective, the holders and marginal buyers will hold on blindly until a dividend cut or similar negative event)
  3. Great Management team, and/or the perception of a great mgmt team - A certain “Larry Bird” hedge fund manager told me that the management team says they are the best in the industry and that they have best corp dev team. CEO says he is a 10.
  4. Their dependence on Wall Street may allow them to survive indefinitely (even if it’s a de facto ponzi). It’s a incestuous, unethical relationship between Wall Street/Consultants/Lawyers/Accountants and… Linn Energy. Linn Energy gives them fees, Wall Street gives it life blood. The other enablers provide a sense of legitimacy (“false walls of integrity”)
  5. No one knows how markets will behave tomorrow, so some of these “hedge” positions may end up benefiting them disproportionately and just when they need it.

Reasons Sell/Short:

  1. Flamboyant and promotional CEO (the kind of guy many like to see fail, or are never surprised when they do fail).
  2. Some accounting concerns, specifically pertaining to cash available to meet distributions. Novastar anyone.. or?
  3. Resembles a ponzi borrower* - They depend on external capital. How much would LINN be worth if Wall Street closed indefinitely? If the equity markets fell 20%? 30%? 40%? If interest rates went to ___ ?
  4. Has that roll-up stench.
  5. High short interest (as a longer duration predictive factor)
  6. High dividend yield (seems counter-intuitive, but higher yield means its currency is cheaper, so equity as currency is less valuable)

Open Questions and Thoughts:

  1. Is Linn Energy today more like a Fairfax Financial of 2006/2007, or more like an Enron?
  2. Need to better understand these “hedges” and their entire speculative/securities book. Need to talk to relevant parties with domain knowledge/familiarity.
  3. It’s a “battleground stock” - Jim Cramer/Leon Cooperman and Hedgeye/Barron’s are the public faces of the bull and the bear (a few others have chimed in, and I know it’s been on many people’s radar). I personally like battleground situations, and have demonstrated the ability to make money off of them…but they’re not for everyone.
  4. The equity price does not appear to be at an extreme (high or low), nor is the recent velocity (price change per unit time) noteworthy.. so it seems that on a market price action basis, there is no “fat pitch”.
  5. I’m going to assume I have no edge, and that I am the “patsy on the table”. I assume Kevin Kaiser, Leon Cooperman’s LINE analyst, and the other parties who are not publicly involved know more about LINE than I do.
  6. Some believe their “hedging” is unorthodox, aggressive.

My current opinion: LINE seems like a cross between an O&G operator, roll-up, and hedge fund. I’m not sure if LINE is more of a Fairfax Financial (of the 2006-2008 time period) or an Enron. My understanding of the Fairfax story is that the shorts were correct about most of the facts, but Fairfax nevertheless ended up surviving and prospering for the following reasons (see its stock price since 2006):

  1. The government did not act upon some of the red flags, specifically the tax-related ones.
  2. Fairfax (to its credit) made a very smart bet against subprime, and it paid off asymmetrically.

1. and 2. allowed Fairfax to ‘overcome’ the red flags. It happens. So LINE could also be a situation where the bears are right about pretty much everything, but a series of unexpected and unlikely events lets it survive and thrive indefinitely… or the bears are flat out wrong. Unlike Fairfax, the cost of being wrong seems higher in the case of LINE because you can get hurt badly both on the carry cost (i.e. dividend) and the risk that the principle rises in market value.

*Ponzi, in the Hyman Minsky sense -

Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt by the non-government sector. He identified three types of borrowers that contribute to the accumulation of insolvent debt: hedge borrowers, speculative borrowers, and Ponzi borrowers.

The “hedge borrower” can make debt payments (covering interest and principal) from current cash flows from investments. For the “speculative borrower”, the cash flow from investments can service the debt, i.e., cover the interest due, but the borrower must regularly roll over, or re-borrow, the principal. The “Ponzi borrower” (named for Charles Ponzi, see also Ponzi scheme) borrows based on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but could not make sufficient payments on interest or principal with the cash flow from investments; only the appreciating asset value can keep the Ponzi borrower afloat.

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