Don’t play poker with a guy named Doc. Don’t eat at a place called Mom’s. And don’t make big bets on stuff you don’t understand. That’s the lesson of Linn Energy LLC (NASDAQ:LINE). Linn Energy LLC (NASDAQ:LINE) fell hard this week after admitting that the SEC was investigating its accounting and its proposed acquisition of another exploration company, Berry Petroleum Company (NYSE:BRY). The company had a deal to buy Berry Petroleum Company (NYSE:BRY) for shares in its affiliated company, LinnCo LLC (NASDAQ:LNCO), valuing Berry Petroleum Company (NYSE:BRY) at $46.24/share.
A short-seller called Hedgeye, run by Keith McCullough, has been hammering on Linn Energy LLC (NASDAQ:LINE) since February, with chief energy analyst Kevin Kaiser holding conference calls where he has said the company is worth, not the $40/share it was worth then, the $35/share it was worth last month, or the $25/share it’s worth today, but more like $8.07/share. McCullough, meanwhile, has been backing his man to the hilt, sending out disparaging tweets about financial reporters who don’t fall in line.
The Truth is Complicated
Getting the truth on the company leads you quickly into the weeds of limited partnerships, cost estimates, and valuation estimates in the age of fracking.
Fracking is a gusher for oil companies, but it’s not the way they did business in the past. When you push water and sand at high pressure into a wellhead, cracking the rock thousands of feet underground, your flow of oil and gas coming back is going to be much more uncertain than when you were just sticking a tube into the ground and sucking.
For this reason Limited Liability Company (LLC) structures like Linn have become popular, as a way to get shareholders the maximum return on their money as possible, as have hedging strategies meant to get the best price for what is produced. In other words, these are not long-term plays.
Hedgeye.com senior energy analyst Kevin Kaiser has been hitting the company since February, alleging that its assets in the Granite Wash play of Oklahoma and Texas are worth just a small fraction of what Linn Energy LLC (NASDAQ:LINE) claims, and that it is dramatically under-estimating the cost of maintaining production. He says the company has been trying to use its credibility with investors to buy other, larger producers, then hedge and milk those assets in order to buy still more. (Full disclosure. I covered one of these sessions and wrote about it.) This sort of thing tends to get personal.
McCullough has tweeted numerous personal attacks against Jim Cramer of CNBC and TheStreet, (Full disclosure. I write for TheStreet) even to the point of tying the fight of Cramer’s own company to that of Linn management. Cramer, for his part, told his own viewers on Mad Money Tuesday that he now had questions about Linn’s management and that may in fact have triggered Wednesday’s rout.
The Right Path Forward
There are two types of investors to address here, those who are heavily into Linn and those who are not.
Those who are into Linn Energy LLC (NASDAQ:LINE) are, unless they’re short, out a lot of money right now. Short interest recently hit a peak, over 11 million shares, with 235 million outstanding, but that is only about 10% over the level achieved when Kaiser first made his short call.
Even Kaiser now says the amount of downside risk remaining in Linn Energy LLC (NASDAQ:LINE) is much lower than it was, perhaps another $5/share, and with prices paid on natural gas and oil now firming, it’s unclear how much further the move can go. At $22.81/share, the price it held mid-day on Wednesday, Linn was priced at a yield of over 12%, which should provide a floor under the share price.
Every move down like this gets a snapback, as shorts seek to cover, and the time to be long Linn may be at hand. Just remember that this is a trade, not an investment, that it does carry risk, and that you’ll need to be ready to get out quickly should there be more substantiation of Hedgeye’s charges.
An even better play might be Berry, which is not being investigated at this time, and which has fallen just 10% in the wake of the Linn disclosures. It’s now close to the levels it was holding before Linn moved for it, and could easily use the present volatility as a way to get out of its current deal and find a better one.
All the above is speculative, of course. The best place to be in all of this was outside of it. But if you’ve lost a lot of money already, you need to either lick your wounds or think of a way back toward breakeven.
Dana Blankenhorn has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Dana is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article The Lesson of Linn originally appeared on Fool.com is written by Dana Blankenhorn.
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