Alliance Resource Partners long term changes

This is the second post in my Alliance Resources series. The first post is here. 

When I get researching a company I have been known to read very old filings just to see how business has changed over time. In a case like Alliance Resource Partners this is critical. ARLP is by-far the best performed coal mining company in America and it has had the same management team since the late 1990s. The changes since that time have all be wrought by management and circumstance.

This company's record is so extraordinary that it is worth understanding it in a very long term manner.

So I started with the oldest Alliance Resources 10-K in the SEC database.

From the form 10-K for the fiscal year 1999 here are the balance sheet:

And the P&L

You will see that gross plant and equipment was $278 million with $103 million of accumulated depreciation.

Here is the production data as given from the same form 10-K.

In 1999, we produced 14.1 million tons of coal and sold 15.0 million tons of coal. The coal we produced in 1999 was 19.9% low-sulfur coal, 19.9% medium-sulfur coal and 60.2% high-sulfur coal. In 1999, approximately 85% of our medium- and high-sulfur coal was sold to utility plants with installed pollution control devices, also known as "scrubbers," to remove sulfur dioxide.

We can work out that they thus produced 2.8 million tons of low sulfur coal, 2.8 million tons of medium sulfur coal and 8.5 million tons of high sulfur coal.

The gross plant and equipment needed to produce a ton of coal was (278/14.1=) $19.7. In other words each ton of production required $19.7 worth of property plant and equipment at cost.

The above mentioned 10-K gave us some operating data as well:

In those days revenue per ton of coal was $23.12 and costs per ton was $18.75. The margin was just under $6 per ton. Maintenance capital expenditure was $6 million - or about 43c per ton of coal produced.

Depreciation, depletion and amortization was $39.7 million or $2.82 per ton.

The company also gave employment data:

EMPLOYEES 

We have approximately 1,360 employees, including 100 corporate employees and 1,260 employees involved in active mining operations. Our work-force is entirely union-free. Relations with our employees are generally good, and there have been no recent work stoppages or union organizing campaigns among our employees.

You can work out from this that each employee produced 10,367 tons of coal annually, each mine employee roughly 11,200 tons of coal annually.

To see the changes wrought we need to compare to the latest 10-K.

Here is the most recent balance sheet:

CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2012 AND 2011 (In thousands, except unit data)

		December 31,
		2012			2011
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	28,283		$	273,528
Trade receivables			172,724			128,643
Other receivables			1,019			3,525
Due from affiliates			658			5,116
Inventories			46,660			33,837
Advance royalties			11,492			7,560
Prepaid expenses and other assets			20,476			11,945
Total current assets			281,312			464,154
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment, at cost			2,361,863			1,974,520
Less accumulated depreciation, depletion and amortization			(832,293	)		(793,200	)
Total property, plant and equipment, net			1,529,570			1,181,320
OTHER ASSETS:
Advance royalties			23,267			27,916
Due from affiliate			3,084			—
Equity investments in affiliates			88,513			40,118
Other long-term assets			30,226			18,010
Total other assets			145,090			86,044
TOTAL ASSETS		$	1,955,972		$	1,731,518
LIABILITIES AND PARTNERS' CAPITAL
CURRENT LIABILITIES:
Accounts payable		$	100,174		$	96,869
Due to affiliates			327			494
Accrued taxes other than income taxes			19,998			15,873
Accrued payroll and related expenses			38,501			35,876
Accrued interest			1,435			2,195
Workers' compensation and pneumoconiosis benefits			9,320			9,511
Current capital lease obligations			1,000			676
Other current liabilities			19,572			15,326
Current maturities, long-term debt			18,000			18,000
Total current liabilities			208,327			194,820
LONG-TERM LIABILITIES:
Long-term debt, excluding current maturities			773,000			686,000
Pneumoconiosis benefits			59,931			54,775
Accrued pension benefit			31,078			27,538
Workers' compensation			68,786			64,520
Asset retirement obligations			81,644			70,836
Long-term capital lease obligations			18,613			2,497
Other liabilities			9,147			6,774
Total long-term liabilities			1,042,199			912,940
Total liabilities			1,250,526			1,107,760
COMMITMENTS AND CONTINGENCIES
PARTNERS' CAPITAL:
Limited Partners—Common Unitholders 36,874,949 and 36,775,741 units outstanding, respectively			1,020,823			943,325
General Partners' deficit			(273,113	)		(279,107	)
Accumulated other comprehensive loss			(42,264	)		(40,460	)
Total Partners' Capital			705,446			623,758
TOTAL LIABILITIES AND PARTNERS' CAPITAL		$	1,955,972		$	1,731,518

   

And here is the most recent P&L statement:

CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010 (In thousands, except unit and per unit data)

		Year Ended December 31,
		2012			2011			2010
SALES AND OPERATING REVENUES:
Coal sales		$	1,979,437		$	1,786,089		$	1,551,539
Transportation revenues			22,034			31,939			33,584
Other sales and operating revenues			32,830			25,532			24,942
Total revenues			2,034,301			1,843,560			1,610,065
EXPENSES:
Operating expenses (excluding depreciation, depletion and amortization)			1,303,291			1,131,750			1,009,935
Transportation expenses			22,034			31,939			33,584
Outside coal purchases			38,607			54,280			17,078
General and administrative			58,737			52,334			50,818
Depreciation, depletion and amortization			218,122			160,335			146,881
Asset impairment charge			19,031			—			—
Total operating expenses			1,659,822			1,430,638			1,258,296
INCOME FROM OPERATIONS			374,479			412,922			351,769
Interest expense (net of interest capitalized of $8,436, $14,797 and $888, respectively)			(28,684	)		(21,954	)		(30,062	)
Interest income			229			375			200
Equity in loss of affiliates, net			(14,650	)		(3,404	)		—
Other income			3,115			983			851
INCOME BEFORE INCOME TAXES			334,489			388,922			322,758
INCOME TAX EXPENSE (BENEFIT)			(1,082	)		(431	)		1,741
NET INCOME		$	335,571		$	389,353		$	321,017
GENERAL PARTNERS' INTEREST IN NET INCOME		$	106,837		$	86,251		$	73,172
LIMITED PARTNERS' INTEREST IN NET INCOME		$	228,734		$	303,102		$	247,845
BASIC AND DILUTED NET INCOME PER LIMITED PARTNER UNIT		$	6.12		$	8.13		$	6.68
DISTRIBUTIONS PAID PER LIMITED PARTNER UNIT		$	4.1625		$	3.6275		$	3.205
WEIGHTED AVERAGE NUMBER OF UNITS OUTSTANDING—BASIC AND DILUTED			36,863,022			36,769,126			36,710,431

   

And here is the production data:

 In 2012, we sold a record 35.2 million tons of coal and produced a record 34.8 million tons of coal, of which 3.8% was low-sulfur coal, 18.8% was medium-sulfur coal and 77.4% was high-sulfur coal. In 2012, we sold 93.1% of our total tons to electric utilities, of which 98.7% was sold to utility plants with installed pollution control devices.

Again we can work out that they produced 1.3 million tons of low sulfur coal, 6.5 million tons of medium sulfur coal and 26.9 million tons of high sulfur coal.

Note that the (high value) low sulfur coal has declined in both relative and absolute terms and this has become almost entirely a high-sulfur coal company company dependent on plants with sulfur scrubbers.

The most profound change is just how capital intensive this business has become. The company has now employed $2,362 million in gross property, plant and equipment with accumulated depreciation of 823 million.

Bluntly - the amount of capital employed here has risen enormously. The gross property, plant and equipment per ton of coal produced is now $67.87 - up a long way from $19.70 per ton.

The last 12 years in the US have not been a period of massive inflation - and the rise in capital intensity of this business is - well - surprising. The capital intensity of this business has gone up 345 percent. The capital employed per incremental ton of capacity is very large indeed.

Here are the employee numbers from the last form 10-K:

To conduct our operations, as of February 1, 2013, we employed 4,345 full-time employees, including 4,091 employees involved in active mining operations, 86 employees in other operations, and 168 corporate employees. Our work force is entirely union-free. We believe that relations with our employees are generally good.

From this we see what I think is the most unusual thing about all the giant capital spend at Alliance Resource Partners. The huge capital equipment spend has not improved labor productivity. Production is now 8009 tons per employee per year - and about 8500 tons per mining employee per year.

Despite all that capital equipment spend labor productivity has dropped by more than 20 percent. Strange.

Moreover the non-mine employees have risen from to 100 to 254 - a rise somewhat faster than the total production has grown. Labor productivity has dropped and the company has become more bureaucratic white-collar heavy.

The company also publishes a long list of operating metrics in the 10-K.

 Our historical financial data below were derived from our audited consolidated financial statements as of and for the years ended December 31, 2012, 2011, 2010, 2009 and 2008.

		Year Ended December 31,
(in millions, except unit, per unit and per ton data)		2012			2011			2010			2009			2008
Statements of Income
Sales and operating revenues:
Coal sales		$	1,979.4		$	1,786.1		$	1,551.5		$	1,163.9		$	1,093.1
Transportation revenues			22.0			31.9			33.6			45.7			44.7
Other sales and operating revenues			32.9			25.6			24.9			21.4			18.7
Total revenues			2,034.3			1,843.6			1,610.0			1,231.0			1,156.5
Expenses:
Operating expenses (excluding depreciation, depletion and amortization)			1,303.3			1,131.8			1,009.9			797.6			801.9
Transportation expenses			22.0			31.9			33.6			45.7			44.7
Outside coal purchases			38.6			54.3			17.1			7.5			23.8
General and administrative			58.8			52.3			50.8			41.1			37.2
Depreciation, depletion and amortization			218.1			160.3			146.9			117.5			105.3
Asset impairment charge			19.0			—			—			—			—
Gain from sale of coal reserves			—			—			—			—			(5.2	)
Net gain from insurance settlement and other(1)			—			—			—			—			(2.8	)
Total operating expenses			1,659.8			1,430.6			1,258.3			1,009.4			1,004.9
Income from operations			374.5			413.0			351.7			221.6			151.6
Interest expense (net of interest capitalized)			(28.7	)		(22.0	)		(30.1	)		(30.8	)		(22.1	)
Interest income			0.2			0.4			0.2			1.0			3.7
Equity in loss of affiliates, net			(14.7	)		(3.4	)		—			—			—
Other income			3.2			1.0			0.9			1.3			0.9
Income before income taxes			334.5			389.0			322.7			193.1			134.1
Income tax expense (benefit)			(1.1	)		(0.4	)		1.7			0.7			(0.5	)
Net income		$	335.6		$	389.4		$	321.0		$	192.4		$	134.6
Less: Net loss attributable to noncontrolling interest			—			—			—			(0.2	)		(0.4	)
Net income attributable to Alliance Resource Partners, L.P. ("Net Income of ARLP")		$	335.6		$	389.4		$	321.0		$	192.2		$	134.2
General Partners' interest in Net Income of ARLP		$	106.8		$	86.3		$	73.2		$	60.7		$	45.7
Limited Partners' interest in Net Income of ARLP		$	228.8		$	303.1		$	247.8		$	131.5		$	88.5
Basic and diluted net income of ARLP per limited partner unit(2)		$	6.12		$	8.13		$	6.68		$	3.56		$	2.39
Distributions paid per limited partner unit		$	4.1625		$	3.6275		$	3.205		$	2.95		$	2.53
Weighted average number of units outstanding-basic and diluted			36,863,022			36,769,126			36,710,431			36,655,555			36,604,707
Balance Sheet Data:
Working capital		$	73.0		$	269.3		$	348.7		$	54.9		$	239.8
Total assets			1,956.0			1,731.5			1,501.3			1,051.4			1,030.6
Long-term obligations(3)			791.6			688.5			704.2			422.5			440.8
Total liabilities(4)			1,250.5			1,107.8			1,045.5			730.4			740.4
Partners' capital(4)		$	705.5		$	623.7		$	455.8		$	321.0		$	290.2
Other Operating Data:
Tons sold			35.2			31.9			30.3			25.0			27.2
Tons produced			34.8			30.8			28.9			25.8			26.4
Coal sales per ton sold(5)		$	56.28		$	55.95		$	51.21		$	46.60		$	40.23
Cost per ton sold(6)		$	38.15		$	37.15		$	33.90		$	32.23		$	30.39
Other Financial Data:
Net cash provided by operating activities		$	555.9		$	574.0		$	520.6		$	282.7		$	261.0
Net cash used in investing activities			(623.4	)		(401.1	)		(295.0	)		(320.1	)		(184.1	)
Net cash provided by (used in) financing activities			(177.7	)		(238.9	)		92.7			(186.6	)		166.8
EBITDA(7)			581.1			570.8			499.5			340.4			257.8
Maintenance capital expenditures(8)			282.6			192.7			90.5			96.1			77.7

We can work out a few more things here - for instance the maintenance capital expenditures are now 282.6 million dollars annually. That is $8.12 per ton produced per year. Back in 1999 maintenance capital expenditure was only 43c per ton produced per year.

That is an 18 fold increase in maintenance requirements per ton produced per year.

An unmitigated record of operational failure

This is very puzzling indeed. Financially this is the best performed coal operation in North America - the stock price is near the all time high. The distributions paid by this MLP are large and increasing. People sing the praises of this management team (particularly on Seeking Alpha but also in the comments on my blog).

But the operational facts on the ground tell a radically different story. This management team demonstrate unparalleled operational failure. The company has radically increased its capital expenditure - and the capital intensity of the business has gone up roughly 350 percent. This is a big-spending management team.

Despite that (and despite their non-unionized workforce) labor productivity has dropped more than 20 percent. And the workforce has become more bureaucratic.

Finally all this new - and seemingly expensive machinery - needs to be maintained. And the maintenance expenditure which was once only 43c per ton per year (less than 2 percent of the price received per ton of coal) is now over $8 per ton of output (over 14 percent of the price received per ton). This business is way more expensive to maintain.

On an operational level this is seemingly the worst run mining operation in the United States (and I am including the bankrupt Patriot Coal). And yet the company has had unparalleled financial success.

Why this might be is the subject of a few more posts.






John

Alliance Resources: astoundingly good - but why?

Alliance Resources (ARLP:NASDAQ) is a listed master limited partnership (MLP) in the coal mining space. The General Partner (AHGP) is also listed. The GP is also structured as an MLP.

Alliance mines roughly 35 million tonnes of coal annually which makes it a big mining operation but only about a seventh of the size of the American giants (Peabody, Arch Coal) and those are small compared to BHP which has over 13 billion dollars in coal revenue.

Alliance is unique among large coal companies in that the stock price and profitability is at an all time high.

Everyone else is suffering - or at least guiding to some sufferance.

This is the first of a series of notes to try and work out why. You can color me skeptical up front. The performance of Alliance is - relative to the competition - flat-out extraordinary. And that gets my spidey-sense on full alert.

Background to Alliance's operations and the current state of the coal industry

Alliance mines are mostly high sulfur and underground - some in the (very) high cost Appalachia but most in the lower cost Illinois Basin.

It is also no secret that the coal mining industry in America is stretched. Very stretched. There are a bunch of reasons - but for thermal coal the main one is that coal fired power stations are closing - driven by two main factors:

• 1. Very low natural gas prices are making gas-generated electricity very cheap - cheaper than coal generated electricity in many cases and

• 2. High environmental costs (especially mercury amelioration) causing plants to close.

These are related problems. It might be worth retrofitting old boilers with scrubbers for mercury if the electricity price were high. But because of cheap gas there is no prospect of that.

And there are plenty of signs of the stress. I am going to quote the last conference call of CSX - the railway company that hauls lots of coal - because it is Alliance's main carrier:

Finally domestic coal declined 21% although the rate of decline moderated somewhat from what we saw earlier in the year. Now let’s take a closer look at some of the individual markets in more detail and let’s start with coal. Coal revenue declined 18% to $747 million. Domestic volume declined 21% as natural gas prices remain low leading to the continued displacement of coal and high stockpiles at many utilities. In addition, electrical generation declined in the Eastern United States. Export coal volume declined 10% as demand for metallurgical coal softened particularly in the Asian markets. Total revenue per unit was flat as core pricing gains in domestic markets offset lower export rates. Looking ahead at this point export coal volume is expected to decline in the first quarter and our best estimate of full year volume is about 40 million tons. 

Furthermore we anticipate our rates to be pressured as we work with producers to keep U.S. coal competitive globally in an environment where underlying commodity process for thermal and metallurgical coal are low. At the same time domestic coal headwinds will persist but we expect them to continue to moderate throughout 2013. As a result we anticipate domestic volume will decline in the 5% to 10% range for the full year.

It is however fair that in this misery Illinois Basin coal has done relatively well. Whilst Powder River Basin (PRB) coal is still cheaper Central Appalachian Coal is flatly noncompetitive. Quoting from the question and answer session in the same conference call:

David Vernon - Sanford Bernstein 

Okay. And just as a quick follow-up with the length of haul increase on the domestic, is that a change in type of coal is it the Illinois Basin coming in perhaps going into a plant that used to be taking PRB or is it just the ebbs and flows across the network? 

Michael Ward - Chairman, President and Chief Executive Officer of CSX 

Some of it is Illinois Basin coal, but it’s not going into plants that took PRB, it was going into plants that took Central App. And the rest of it has just been the ordering patterns of the utilities fulfilling their coal contracts.

This appraisal of Illinois Basin coal displacing Appalachia coal is widely reported. The Energy Information Administration has reported the same thing - with rising volumes for Illinois basin coal but falling prices. They have reported falling prices and volumes for Appalachian coal.

Alliance has bucked these trends. It has produced rising volumes in both the Illinois Basin and the Northern Appalachia (with falling volumes in the Central Appalachia due to regulatory issues). And - contrary to all industry trends - they are reporting rising prices in the Illinois Basin. Specifically in the recently filed 10-K the price achieved in the Illinois Basin rose from $50.45 per ton in 2011 to $52.51 per ton in 2012. Not only are these prices not following industry trends but they are several dollars per ton higher than prices reported on Bloomberg for Illinois Basin coal of similar grades.

Coal mining is not a complicated business - and unless you have a substantially better resource than anyone else it is difficult to make these sort of numbers. Moreover whist one mine may be extraordinary  Alliance operates eleven mines. It is unlikely they are all extraordinary.

So it must be something done by the management. Something truly extraordinary done by the management. The main point of this series of blog posts is to work out precisely what.




John

PS. As readers know I am a short seller. Whenever I see something like this I am skeptical. In this case you can assume I am short.

Revisiting Titanium Asset Management

I had almost entirely forgotten about Titanium Asset Management in outer Sydney until Friday when an anonymous person left this comment on my blog:

Hempton, you are one sad person. Look at the crap you write. Your mother must be ashamed of you.

And yes - I confess they got the first bit right. There is a little bit of sadness here.

But to explain my sadness you need to revisit my post on Titanium Asset Management and their fictional returns.

Titanium's website is not there any more (and I attribute that partly to my post and partly to the related articles in the Sydney Morning Herald).

Whatever: you can still find the website at archive.org.

Here is a picture of Titanium's returns versus the ASX200.

(The original along with a long series of monthly entry and exit prices can be found at this link...)

These returns were of course fictional (the "fund manager" later said they came from "paper trading" even though the original documents described them as audited).

When the auditor confirmed to me that he never audited the returns - well that sort of clinched it.

As I said Titanium Asset Management's website has disappeared.

Briefly Titanium Asset Management renamed themselves "Wedgetail Asset Management" but that website has also disappeared. The website contact in the whois database is Andrew Blanchette*.

One of the fund managers at Titanium has wound up as the "Investment Governance and Reporting Manager" at a reputable financial institution.

And Blanchette remains the Chief Executive Officer of a large financial planning dealer group called - you guessed it - Titanium.

Nobody has been criminally charged for marketing a funds management business on false returns.

So unfortunately I am sad.

Whether my mum is proud of me - that is another question. She always had a penchant for calling a spade a shovel - and I am proud of her.




J

*An aside. Australians may know why Blanchette is otherwise famous. Short version: he was a boyfriend of a model - Carolyne Byrne. Carolyne Byrne was found dead at the Gap - a Sydney suicide spot. Her later boyfriend Gordon Wood was convicted of murder. Blanchette publicly accused Wood of the murder. Wood protested his innocence and accused Blanchette of the murder. Blanchette was investigated and cleared. Wood's conviction was later overturned as a miscarriage of justice. Probable truth - she committed suicide - possibly induced by SSRIs - and nobody is guilty of murder. The longer version is more colorful because it involves prominent but now dead members of the Sydney business community - alas the longer version is a probable mash of falsehoods too...

Gulfport energy's accounts payable and accrued liabilities

Gulfport Energy reports later this week. Strangely one of the balance sheet items that most intrigues me is their accounts payable and accrued liabilities.

Here is the current liability section from the last 10-Q.

GULFPORT ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS (Unaudited)
	September 30, 2012				December 31, 2011
Current liabilities:
Accounts payable and accrued liabilities	$	107,058,000			$	43,872,000
Asset retirement obligation - current	60,000				620,000
Short-term derivative instruments	8,816,000				—
Current maturities of long-term debt	147,000				141,000
Total current liabilities	116,081,000				44,633,000

I just want you to note that accounts payable and accrued liabilities are just over 107 million. That is up from 44 million at December 2011 and from 96 million in the second quarter.

And here is the profit loss statement listing all expenses for the past nine months.

GULFPORT ENERGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
	Three Months Ended September 30,								Nine Months Ended September 30,
	2012				2011				2012				2011
Revenues:
Oil and condensate sales	$	58,609,000			$	56,447,000			$	187,633,000			$	154,559,000
Gas sales	973,000				923,000				2,127,000				3,155,000
Natural gas liquids sales	874,000				653,000				2,374,000				2,346,000
Other income	81,000				58,000				189,000				248,000
	60,537,000				58,081,000				192,323,000				160,308,000
Costs and expenses:
Lease operating expenses	6,638,000				5,744,000				18,201,000				15,103,000
Production taxes	7,070,000				6,281,000				22,411,000				18,520,000
Depreciation, depletion, and amortization	25,377,000				14,736,000				70,424,000				40,606,000
General and administrative	3,098,000				2,034,000				9,370,000				6,209,000
Accretion expense	176,000				168,000				529,000				491,000
	42,359,000				28,963,000				120,935,000				80,929,000
INCOME FROM OPERATIONS:	18,178,000				29,118,000				71,388,000				79,379,000

I want you to notice that the only expenses in the past nine months are:

• 18.2 million of lease operating expenses
• 22.4 million of production taxes
• 70.4 million of depreciation, depletion and amortization
• 9.4 million of general administrative expenses, and
• 0.5 million of accretion expense (though I am not sure I know what that is).

The depreciation, depletion and amortization is - I presume - non cash. Cash expenses for the nine months add up to about $50 million.

I presume most of those were paid relatively promptly. (It does not endear you to regulators for instance if you do not pay your production taxes.)

Simple question

What sort of business is it that accrues $107 million in (unpaid) current liabilities but incurs only about $50 million of expense over the past nine months?

I have spent a bit of time puzzling out the answer - but I will leave that for another post.






John

Disclosure: short Gulfport.

Linn Energy: that did not work so well

From the original 8-K which triggered this series of posts:

Fact #1 – LINN is confident in the validity and accuracy of its audited financial statements.

Drolly I note that for 2012, the company reported net loss of $387 million, or $1.92 per unit. For the quarter the loss was $187 million. (Source here.) Obviously a good part of this loss was write-downs from writing off oil and gas properties that became less valuable as gas prices fell.

However there should be an offsetting write-up in the value of the hedges so that defense will get only so far.

Whatever: unusually for a stock I write about in Linn's case I (mostly) believe in the validity of the accounts. The accounts say quite bluntly that

(a). This is a loss making enterprise.
(b). That this business pays out large and increasing distributions despite those losses and
(c). The business raises ever increasing amounts of funds using ever-more-novel ways of doing it.

To me that looked like a Ponzi scheme on its last legs. Indeed to come to a different conclusion I thought you had to accept some non-standard non-GAAP measures as reality. In other words you have to ignore the audited bottom line for the company.

Many people it seems do ignore the bottom line. They are encouraged by the management - and they might be right - but for the moment I have (and retain) a different opinion.

But I was wrong

Despite not changing my opinion on the fundamentals of Linn I will confess to being wrong on one important (nay critical) point.

When Linn launched Linco (their non-MLP associate which exists only to hold interests in Linn) I thought the money-raising was on its last legs. Specifically I thought that rather than target the non-sophisticated mom-and-pop investors who buy MLPs they were being forced to target more sophisticated investors as they had run the non-sophisticates out of money.

I thought LinnCo meant Linn was on its last legs.

I was wrong. Spectacularly (and unprofitably) wrong.

Yesterday (as many will have noticed) Linn used Linco stock as a currency to buy a C-Corp - a very big acquisition - their biggest to date.

I did not see it coming. It was not even on my original list of risks in the position. Wrong!

This is a great deal for Linn. They get to swap what I believe to be near-worthless stock for some old - but still valuable oil assets. Those assets will generate cash - cash that can keep this whole thing rolling along for a few more years.

So even if I am right that Linn is a Ponzi (and many company supporters disagree with me) it is not a Ponzi that will collapse next week. And so my opportunity to profit will not be next week.

I covered most of my short.

For a loss.




John

PS. The company now has some time to prove that it is not a Ponzi. Substantial GAAP profits might be a start - but hey - ten more years of distributions would also be effective.

Linn Energy per flowing barrel

A fairly standard oil-and-gas valuation metric is the price per flowing barrel for oil and gas.

Oil at $100,000 per daily flowing barrel is considered high end - but some transactions happen at higher prices when there are further development opportunities in the field and the oil is light, sweet crude.

Flowing gas (per BTU) is typically worth about half flowing oil. [Use a conversion that 6 Mcf of gas is equivalent to about 1 barrel of oil]. So lets call this $50,000 per flowing barrel equivalent.

Natural gas liquids trade at about half the price of oil - and so a flowing barrel should be worth about half a flowing barrel of oil. Also lets call this $50,000 per flowing barrel equivalent.

These are fairly standard metrics and any oil and gas analyst should be able to confirm that I am not rigging the numbers here.

Linn Energy per flowing barrel

Here - from the last form 10-Q is the average daily production of Linn Energy for the last quarter by different types of hydrocarbon:

	Three Months Ended September 30,
	2012				2011				Variance
Average daily production:
Natural gas (MMcf/d)	409				170				141	%
Oil (MBbls/d)	30.8				22.6				36	%
NGL (MBbls/d)	31.4				12.2				157	%
Total (MMcfe/d)	782				379				106	%

The increase is not driven by field development but by buying almost $2.5 billion in new assets.


Using the metrics above:

• The gas production is worth 409,000*$50,000/6 = $3.41 billion. 
• The oil production is worth 30,800*$100,000 = 3.08 billion and
• The NGL production is worth 31,400*$50,000= 1.59 billion

The total valuation of the hydrocarbons is thus 8.08 billion as per the flows in the last 10-Q.

The last 10-Q also showed LINN as having debt of $6.84 billion in debt. So the equity would be worth 1.24 billion.

There were 199 million units outstanding as per the last 10Q. This gives an equity valuation of $6.22 per unit - a fair bit lower than the current price of $36.65 per unit. Longs can expect an 80 percent loss on their units using these valuations.

My view is that Linn Energy's gas and oil fields are pretty clapped out - and worth considerably less than the above metrics. The average well flows about 6 barrels per day! [My personal view: the debt will be impaired.]

However even at a full price this MLP is worth under $7 per unit.

To be fair though - this company has purchased a lot of in-the-money options and its option position is valuable. The value of those is about $900 million - which is almost $4 more per unit.

To get anything like the price targets of the bullish analysts are putting on it you need to think these clapped out assets are worth $200,000 per flowing barrel.

I know, I know you object: MLPs are not valued on their underlying assets. They are valued on their yield.

And they are. Until the yield stops.




John