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SEC Inquiry Casts Shadow on Linn-Berry Deal

Shares of Linn Energy LLC and LinnCo LLC got a beat-down last week after the companies disclosed that the Securities and Exchange Commission (SEC) was looking into details of LinnCo's planned merger with Berry Petroleum Co. as well as its hedging strategy and use of financial reporting metrics that aren't required under SEC's generally accepted accounting principles (GAAP).

The disclosure was enough to elicit an enthusiastic "told you so" from one group of analysts while others kept a more positive outlook. Research analysts at Hedgeye said on the firm's website that it was about time that the SEC looked into the Linn companies and that investors grew skeptical.

"For the record, Hedgeye believes this SEC inquiry puts the proposed [Linn-Berry] merger at serious risk," Hedgeye said last Wednesday. "And yes, we believe the stock has room to fall much further. In fact, Hedgeye believes that fair value for LINE (LNCO) is around about 8.00/unit (share)."

After last week's disclosure, Linn shares closed down nearly 19% Tuesday at $27.04 and trended down from there the rest of the week, closing at $23.41 on Friday. On Tuesday, LinnCo was off more than 16%, closing at $30.90 and trending down to close at $26.63 on Friday. Berry Petroleum shares lost nearly 6% Tuesday, closing at $39.85 and $39.90 on Friday.

"Hedgeye energy analyst Kevin Kaiser has been all over the 'Old Wall Street' aggressive accounting practices over at Linn Energy," the firm said. "Kaiser first sounded the siren back in February when the stock was trading around $38. It's currently trading around $23 dollars."

Earlier this year, Barron's picked up on Kaiser's negative take on Linn, that cash flow weakness is masked by its use of non-GAAP accounting. Linn has hedged all of its oil and gas production through 2016 with put options. However, it excludes the cost of the puts when calculating cash flow but includes hedging gains.

Linn and LinnCo said the SEC's Fort Worth, TX, office had begun a private inquiry involving the companies and had requested the preservation of documents and communications potentially relevant to, among other things, LinnCo's proposed merger with Berry (see NGI, Feb. 25) and Linn and LinnCo's use of non-GAAP financial measures and hedging strategy. At the time it was announced, the Linn-Berry deal was touted as the first-ever acquisition of a public C-Corp. by an upstream LLC or MLP.

Analysts at Wunderlich Securities had a more positive take on the investigation and what it might mean for the Linn-Berry deal. "While it's always nice to be a pioneer, in theory, given the glory and honor bestowed upon a successful deal, behind the scenes there are many issues that have likely never been dealt with before, both from a company and regulatory perspective, that take time to sort out," they said last week. "The fact this deal has taken longer than expected is not a surprise, nor a concern, to us."

The $4.3 billion tie-up of Linn Energy and its LinnCo unit with Berry would create one of the largest exploration and production (E&P) companies in North America. The companies said Berry's "long-life, low-decline, mature assets are an excellent fit for an MLP/LLC" and will bring "meaningful growth" to Linn's portfolio, adding a geographic presence in California, the Permian Basin, East Texas and the Rockies, as well as a new core area in the Uinta Basin.

Linn and LinnCo said they are cooperating with the SEC. "Although the impact of the inquiry on the timing of LinnCo's proposed merger with Berry Petroleum Co. is difficult to predict, LinnCo and Linn remain committed to the completion of the transaction," the companies said.

"[Berry] shares are now trading basically at a price similar to when the deal was announced (under $39/share) due to the uncertainty that continues to float around the deal," Wunderlich said. "At this point, we feel that the shares provide a pretty strong risk-reward profile; if the deal falls through, it shouldn't get hit much, and if it goes through as planned currently, it would move over $40/share, providing a nice short-term return. We feel all three parties still want to get this deal done and behind them and that the SEC issues can be worked through and a shareholder vote can also be worked out. While delays and black clouds do exist, we feel these are opportunities for investors looking for ample return in a short period."

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