Updated from 12:43 p.m. ET to include closing share prices and additional data throughout
NEW YORK (
said late on Monday the
Securities and Exchange Commission
has opened an informal inquiry into its financial disclosures and the driller's pending merger with
The Houston-based company said in a statement it has voluntarily agreed to disclose information to the SEC's informal review and that the regulator has requested the preservation of documents and communications relevant to the company's proposed merger with Berry Petroleum, its use of non-GAAP financial measures relayed to investors and its hedging strategies.
Linn, however, said it remains confident it will complete its merger with Berry and that the informal inquiry shouldn't be seen as a negative stance by the SEC of its business.
"The SEC has stated that the fact of the inquiry should not be construed as an indication that the SEC or its staff has a negative view of any entity, individual or security," the company said in a statement. "Although the impact of the inquiry on the timing of LinnCo's proposed merger with Berry Petroleum Company is difficult to predict, LinnCo and LINN remain committed to the completion of the transaction."
LINN and LinnCo, a unit the company is using to acquire Berry, are cooperating fully with the SEC, both companies said.
On Monday, Linn Energy and LinnCo maintained their high dividend yields by announcing monthly cash distributions of $0.2416 per share, or $2.90 on an annualized basis. The distribution will be payable to shareholders of record as of the close of business on July 10.
"While we remain confident in LINN's overall financial health and the soundness of its financial statements, we cannot ignore the uncertainty that the SEC inquiry has brought to the partnership's near-term outlook," Kevin Smith, a Raymond James analyst wrote in a Tuesday downgrade of the company. The analyst said the inquiry could delay the Berry deal by at least 30 days, however, Linn's business model and outlook "remain sound."
Linn Energy shares closed down nearly 19% to $27.05 in Tuesday trading. LinnCo shares fell nearly 17% to $30.90, while Berry Petroleum shares fell nearly 6% to $39.86.
Berry's proposed merger comes amid scrutiny from major financial media and independent research firms into earnings and cash flow of Linn Energy.
Questions about the ability of Linn Energy to fund its large dividend and its accounting practices on derivative hedges have caused significant volatility in the company's shares and its all-stock exchange with Berry.
The SEC's informal review, while not a confirmation of concerns about Linn's accounting, likely creates a new challenge for the oil and gas driller. A handful of analysts downgraded their ratings and price targets for Linn Energy given the uncertainty of the review, however, few expressed concern over the company's long-term earnings or strategy.
In late June, Sterne Agee analyst Tim Rezvan said Berry Petroleum was fairly valued at $44 a share in the company's anticipated stock merger with Linn.
In the wake of the SEC's informal review Rezvan wrote Tuesday, "we see 15% upside in
Berry shares if the deal closes on schedule this quarter, and 17% downside if the deal breaks."
Linn and Berry said in late March they had delayed a shareholder meeting on their merger until the third quarter of 2013. Both companies expressed confidence in a close of the merger.
The SEC's concern likely relates to Linn's practice of reconciling its GAAP operating cash flow with a non-GAAP measure it calls distributable cash flow (DCF), Rezvan said. To derive DCF, Linn has capitalized the cost of premiums it pays for puts contracts to hedge its energy price risk.
Linn said earlier this year it did not expect to buy additional put contracts, however, the practice has boosted DCF by $911 million from 2009-2012, and by $583 million in 2012, Rezvan calculated.
"While clearly expensing these costs represents the more conservative approach to calculating DCF, we believe recent chatter around the issue overstates the impact of this convention on LINE's financial metrics," Praneeth Satish, a Wells Fargo analyst, wrote in a Tuesday client note.
Linn's distributable cash flow covered 88% of its recently increased dividend payments, even as the company reported a GAAP net loss in its most recent quarter.
Satish valued Linn Energy's natural gas put portfolio at about $330 million, given current prices. A sale of the portfolio, Satish said, would not impact forecasts on Linn's five-year dividend growth rate.
Hedgeye Risk Management
put a spotlight on derivative accounting practices at Linn Energy that the investment community had already brought to light, Rezvan of Sterne Agee said in June
Leon Cooperman of
said in late June the hedge fund had received positive feedback from Berry Petroleum's management on its merger with Linn Energy.
Cooperman said in a June 19
interview the $8.4 billion hedge fund has also
on Linn Energy and remains an investor in the embattled company.
Omega Advisors is Linn Energy's largest outside investor, with a 3.05% holding in the company's shares worth more than $200 million, according to March 31 SEC filings compiled by
. Omega also owns 1.96% of LinnCo, the data show.
Omega Advisors isn't concerned with how Linn Energy accounts for a hedging program the firm has in place to reduce its exposure to volatile energy prices, Cooperman said to
Through a spokesperson, Omega Advisors declined to comment on Linn Energy's Monday disclosure of an informal SEC review.
Linn Energy has seen its shares fluctuate sharply as both
and Hedgeye question Linn Energy's ability to fund its current dividend and, consequently, the company's share price.
Linn's stock valuation and the strength of its financial position are of big importance as the company works to close the all-stock transaction of LinnCo and Berry Petroleum.
Were that merger to be completed, Linn Energy said it will be able to increase its annual dividend to $3.08 a share, or a yield of about 9% at current share prices.
In mid-June, Hedgeye Risk Management hosted a conference call to detail its analysis of why Linn Energy's dividend may be hard to support and its shares are overvalued.
In the wake of Hedgeye's analysis
first reported Cooperman's
of the company as its leading outside shareholder.
In a letter sent to
that was published on June 22, Cooperman noted that Linn's non-GAAP distributable cash flow metric would, by definition, exclude the costs of its capitalized energy hedges. In response
said Linn's deduction of those costs from Ebitda and DCF presented an "incomplete and overly optimistic picture" of the company's financial health. It favors GAAP metrics such as Linn's quarterly net loss of $222 million.
Jim Cramer, founder of
and contributor to
Real Money Pro
, currently owns Linn Energy shares in his Action Alerts PLUS charitable trust, along with co-portfolio manager Stephanie Link. Cramer has supported Linn Energy and invited CEO Mark E. Ellis on his
On Tuesday, Link said in a
Real Money Pro
that the charitable trust would sell 1,400 Linn Energy shares at $29 apiece.
"Our rules have always been to sell a stock with an SEC investigation -- because we have no edge in knowing what the outcome will be," Link wrote, while noting that the company's net asset value (NAV) remains unchanged at $40 a share and it continues to carry a 8.7% dividend yield.
Link said Action Alerts PLUS would continue to own 1,000 Linn Energy shares after its stake sale, roughly 1.2% of the overall portfolio.
-- Written by Antoine Gara in New York