investment report

Linn Energy, LLC (LINE)

business overview
Linn energy’s mission, as recorded on its website, is to “acquire, develop and
maximize cash flow from a growing portfolio of long-life oil and natural gas
assets.” The company’s core areas of operation are the mid-continent,
California, and the Permian basin.

The company invests in energy and through acquisition of oil and natural gas
properties that offer long-life, high quality production with relatively predictable
decline curves. The company strategizes by operating its assets so that it adds
value through reserve growth, production growth and future operational
synergies. Most importantly, the company reduces cash flow volatility through
commodity price and interest rate hedging.

The company is currently headquartered in the capital of oil and gas, Houston,
TX.

industry outlook

The oil and gas energy industry is characterized by volatility and high
technology cost. As one of the necessities of modern life, oil and gas energy is
at a slippery slope characterized by capital-intensive operations and threat of
renewable energy. Demand of oil and gas is driven by economic activity,
population growth, and energy efficiency, especially in developing nations. The
US oil and gas exploration and production industry consists of about 6000
companies with combined annual revenue of about $230billion.

The profitability of each individual firm is driven by the success rate (by
avoiding dry holes), the ability to increase production from existing wells, and
the value of the land after the depletion of the gas. Big players such as Exxon
Mobil, Chevron, and ConocoPhilipps have the access to capital and the ability to
vertically integrate gas production from extraction to marketing. However,
many small players, such as Contango or Southwest Energy, whose edge lies in
outsourcing as much as possible, employs the best geologists and subcontracts
out all drilling and completion.

There are four stages to the extraction of oil and gas:

 • exploration: geologist study the rock formation of an area and hire
seismic companies to run tests. Judging from that, geologist decides
whether they should start drilling.
• Once decision is made, a contract is signed with drilling and
completion companies such as Halliburton, who manages moving
heavy equipments around and arranges water tanks ready.
• Once a hole is drilled, the drilling company pumps in large quantities
water and wait for the gas to resurface. This is the most nerve-
wracking period of the drilling process as drilling costs around 3
millions dollars, but there’s never guarantee whether this will be a dry
hole or not.
• Once gas pumps up, it’s time for the distribution and marketing
department to take over. Marketing department usually lies the pipe
lines in exchange for a certain period of exclusive right of distribution
at a certain price.
• Gas comes to your house!

Recent development in the oil and gas industry includes shale gas in
Susquenhanna County, PA, and Barnett shale gas, also some area in AR.

Off shore drilling is another variety, which is even more capital intensive.
Technology is used extensively to create the seismic 2D and 3D subsurface
maps.

competition

competitor company description implications for LINE

Anadarko Founded in 1959 and headquartered in Woodlands, Texas, While there is overlap in the
Petroleum APC engages in the exploration and production of oil and gas area of exploration, Anadarko
Corporation properties primarily in the United States, the deepwater of the Petroleum Corporation seems
(APC) Gulf of Mexico, and Algeria. The company markets natural to be increasing its focus on its
gas, crude oil, condensate, and oil and natural gas liquids international operations in
(NGLs), as well as owns and operates natural gas gathering, China, Brazil, Ghana, and
treating, and processing systems. The company also engages in Indonesia. APC has been
the hard minerals business through non-operated joint ventures around longer, but is also
and royalty arrangements in various coal, trona, and industrial involved in a much broader
mineral mines located on lands within and adjacent to its Land range of businesses, which
Grant holdings. In addition, it purchases natural gas, crude oil, reduces the likelihood of direct
condensate, and NGL volumes for resale. competition.
Forest Oil Forest Oil Corporation was founded in 1916 and is based in FST could be limited in its
Corporation Denver, Colorado. It engages in the acquisition, exploration, profitability since it only
(FST) development, and production of natural gas and liquids conducts short-term contracts.
primarily in North America. The company principally sells Given the volatile nature of the
natural gas on a month-to-month basis in the spot market under industry, it seems to be very
short-term contracts. risky and will probably not
directly compete with LINE.
Pioneer Natural Founded in 1997 and headquartered in Irving, Texas, Pioneer There is significant overlap in
Resources Natural Resources Company engages in the exploration and the areas of exploration
Company production of oil and gas in the United States, South Africa, between PXD and LINE. In
(PXD) and Tunisia. It produces crude oil, natural gas, and natural gas addition, PXD is investing in
liquids. The company primarily holds interests in the Spraberry Africa, which could either
field in the Permian Basin area; the Hugoton and West prove to be very profitable or
Panhandle fields in the Mid-Continent area; and the Raton end in fiasco. Either way, it is
field in the Rocky Mountains area. definitely a competitor to
watch out for.
ConocoPhillips ConocoPhillips was founded in 1917 and is based in Houston, The fact that COP is looking at
(COP) Texas. The company operates through six segments: alternative forms of energy
Exploration and Production (E&P), Midstream, Refining and could allow it to detach itself
Marketing (R&M), LUKOIL Investment, Chemicals, and from the volatile nature of the
Emerging Businesses. It operates worldwide and has around oil market. However, it’s E-
30,000 full-time employees. Gas technology may fail. In
addition, COP is a very large
company and could to subject
to the same problems as other
large oil and gas companies.

financials
income statement
Given Linn’s status as a relatively new company and its exposure to the swings
in the oil markets, net income has been very volatile over the past few years.
Linn’s revenue has depended heavily on commodity prices. During periods of
high prices/high demand, the firm has produced more. The gross margin and
operating margin have decreased when production decreases, which implies
increasing economies of scale (or high fixed costs of operation.) Despite recent
weakness in the commodities markets, Linn has able to lock in higher prices
due to their hedging strategies in the derivative markets. Thus, during times of
low prices, Linn has been able to sell their products at above market prices.
Conversely, in times of high prices, Linn has sold below market value. Net
income results on Linn’s income statement may be slightly misleading because
unrealized gains on derivatives are incorporated into net revenue along with
the realized gains. Linn’s hedging strategy has allowed it to pay a dividend of
63¢ per quarter, even in times of negative net income due to volatile
commodity prices.
In Millions of USD 2008 2007 2006 2005

Revenue $1,431.27 $ (78.02) $ 124.68 $ (26.83)

Other Revenue, Total $ 3.76 $ 2.74 $ 0.85 $ 0.34
Total Revenue $ 1,435.03 $ (75.28) $ 125.53 $ (26.48)
Cost of Revenue, Total $ 115.40 $ 41.95 $ 6.60 $ 7.36
Gross Profit $ 1,315.87 $ (119.97) $ 118.08 $ (34.18)
Selling/General/Admin. Expenses, Total $ 168.93 $ 88.40 $ 38.29 $ 7.73
Research & Development $ 7.60 $ 4.05 $ 0.29
Depreciation/Amortization $ 194.09 $ 69.08 $ 4.35 $ 7.29
Interest Expense(Income) - Net Operating $ - $ - $ - $ -
Unusual Expense (Income) $ (48.26) $ 1.77 $ 0.03 $ -
Other Operating Expenses, Total $ - $ - $ - $ -
Total Operating Expense $ 437.77 $ 205.25 $ 49.56 $ 22.38
Operating Income $ 997.26 $ (280.53) $ 75.97 $ (48.86)
Interest Income(Expense), Net Non-
Operating $ - $ - $ - $ -
 Gain (Loss) on Sale of Assets $ - $ - $ - $ -
Other, Net $ (7.70) $ (3.82) $ (2.58) $ (0.37)
Income Before Tax $ 828.37 $ (351.41) $ 67.84 $ (56.28)
Income After Tax $ 825.66 $ (356.19) $ 69.81 $ (56.35)
Minority Interest $ -
Equity In Affiliates
Net Income Before Extra. Items $ 825.66 $ (356.19) $ 69.81 $ (56.35)
Net Income $ 999.62 $ (364.35) $ 79.19 $ (56.35)

balance sheet
Linn’s balance sheet appears healthy, with a 42% debt to capital ratio and a
2.05 current ratio. Linn also has a $1.75 credit facility to cover any short-term
obligations it may incur. (Currently, the company holds about 205 million in
current liabilities and 1.82 billion in non-current liabilities). In 2009, Linn’s three
largest customers represented 23%, 18%, and 15% of the company’s sales and
trade accounts receivable from three customers were more than 10% of the
Company’s total trade accounts receivable. This dependency on large
customers could serve as a potential risk for Linn if a credit crisis were to arise
in the near future. Since 2005, Linn’s total assets have grown exponentially
from $280.92 million to $4.72 billion. In addition, Linn’s debt to capital ratio has
declined over this period from a high of 95% to a 35% current ratio. In the
summer of 2009, Linn acquired additional oil and gas properties in the Permian
Basin in Texas ad New Mexico for $113.8 million. Hopefully, the timing of this
acquisition was well-timed to optimize the potential return from these
properties.
In Millions of USD (except for per share
items) 2008 2007 2006 2005

Cash & Equivalents $ 28.67 $ 1.44 $ 6.59 $ 11.04

Short Term Investments $ - $ - $ - $ -
Cash and Short Term Investments $ 28.67 $ 1.44 $ 6.59 $ 11.04
Accounts Receivable - Trade, Net $ 144.88 $ 149.85 $ 19.12 $ 17.75
Receivables - Other $ - $ - $ - $ -
Total Receivables, Net $ 144.88 $ 149.85 $ 19.12 $ 17.75
Total Inventory $ - $ - $ 0.58 $ 0.07
Prepaid Expenses $ - $ - $ - $ -
Other Current Assets, Total $ 390.38 $ 31.87 $ 42.91 $ 5.87
Total Current Assets $ 563.93 $ 183.16 $ 69.21 $ 34.73
Property/Plant/Equipment, Total - Gross $ 3,942.64 $ 3,656.15 $ 789.27 $ 253.02
Goodwill, Net $ - $ 64.42 $ - $ -
Intangibles, Net $ - $ - $ - $ -
Long Term Investments $ - $ - $ 20.09 $ -
Other Long Term Assets, Total $ 507.42 $ 36.62 $ 62.57 $ 4.37
$ $ $
Total Assets 4,722.02 $ 3,807.70 905.91 280.92
Accounts Payable $ - $ - $ - $ 1.21
Accrued Expenses $ 27.16 $ 14.43 $ 2.08 $ 1.45
Notes Payable/Short Term Debt $ - $ - $ - $ 60.00
Current Port. of LT Debt/Capital Leases $ - $ - $ 0.87 $ 0.11
Other Current liabilities, Total $ 47.01 $ 6.15 $ 1.84 $ 18.18
Total Current Liabilities $ 237.83 $ 242.73 $ 17.55 $ 86.56
Long Term Debt $ 1,653.57 $ 1,443.00 $ 425.75 $ 207.69
Capital Lease Obligations $ - $ - $ - $ -
Total Long Term Debt $ 1,653.57 $ 1,443.00 $ 425.75 $ 207.69
Total Debt $ 1,653.57 $ 1,443.00 $ 426.62 $ 267.81
Deferred Income Tax $ - $ - $ - $ -
Minority Interest $ - $ - $ - $ -
Other Liabilities, Total $ 69.94 $ 95.33 $ 11.65 $ 33.50
$ $ $
Total Liabilities 1,961.33 $ 1,781.06 454.96 327.75
Redeemable Preferred Stock, Total $ - $ - $ - $ -
Preferred Stock - Non Redeemable, Net $ - $ - $ - $ -
Common Stock, Total $ 2,109.09 $ 2,374.66 $ 434.62 $ 16.02
Additional Paid-In Capital $ - $ - $ - $ -
Retained Earnings (Accumulated Deficit) $ 651.60 $ (348.02) $ 16.33 $ (62.85)
Treasury Stock - Common $ - $ - $ - $ -
Other Equity, Total $ - $ - $ - $ -
$ $ $
Total Equity 2,760.69 $ 2,026.64 450.95 (46.83)
Total Liabilities & Shareholders' Equity $ 4,722.02 $ 3,807.70 $ 905.91 $ 280.92
Shares Outs - Common Stock Primary Issue $ - $ - $ - $ -
Total Common Shares Outstanding $ 114.08 $ 113.82 $ 42.80 $ 27.83
statement of cash flows
Despite negative net income in the past 3 quarters, Linn actually managed to
have a positive cash flow from operating activities due to realized gains on its
portfolio of derivatives. This seems to be the general trend for Linn. Periods of
low or negative net income are boosted by realized gains from their hedging
strategy. This period, Linn repositioned itself in the derivatives market due to
their belief that energy prices will continue to be weak in the future. Overall
cash decreased in these past 3 quarters due to the recent acquisition and other
capital expenditures. Hopefully these investments will lead to greater future
cash flows and growth.

In Millions of USD (except for per share

items) 2008 2007 2006 2005
Net Income/Starting Line $ 999.62 $ (364.35) $ 79.19 $ (56.35)
Depreciation/Depletion $ 200.31 $ 94.20 $ 22.30 $ 7.29
Amortization $ - $ - $ - $ -
Deferred Taxes $ - $ 3.36 $ (3.43) $ -
Non-Cash Items $(1,001.05) $ 158.93 $ (104.65) $ 24.84
Changes in Working Capital $ (19.35) $ 63.05 $ (0.21) $ (5.30)
$ $ $ $
Cash from Operating Activities 179.51 (44.81) (6.80) (29.52)
Capital Expenditures $ (602.52) $(2,683.81) $ (484.69) $ (150.85)
Other Investing Cash Flow Items, Total $ 566.97 $ (208.61) $ (66.94) $ (0.05)

$
Cash from Investing Activities (35.55) $ (2,892.42) $ (551.63) $ (150.90)
Financing Cash Flow Items $ (20.65) $ (40.45) $ (5.91) $ (5.34)
Total Cash Dividends Paid $ (289.92) $ (154.96) $ (32.06) $ -
Issuance (Retirement) of Stock, Net $ (15.00) $ 2,112.60 $ 433.70 $ -
Issuance (Retirement) of Debt, Net $ 208.83 $ 1,014.89 $ 158.26 $ 194.60
$ $
Cash from Financing Activities $ (116.74) $ 2,932.08 553.99 189.27
Foreign Exchange Effects $ - $ - $ - $ -
$ $ $ $
Net Change in Cash 27.23 (5.15) (4.45) 8.85
valuation
Linn’s current Price/Earnings ratio is 4.413. This is low relative to that of the market
(S&P 500), which is at 19.84. Linn’s low P/E ratio could indicate that the stock is
undervalued, or it could simply be the result of lower expected future earnings. Linn’s
low Price to Tangible Book ratio indicates that the company is valued at about what its
assets are worth.

key LINE comparison compariso implications for LINE

metric to industry n to S&P
500
Linn has a relatively low PE ratio in
comparison to the industry and the
S&P 500, which means that it is very
attractive from a valuation standpoint.
PE Ratio 4.413 N/A 19.84
However, this may also mean that
investors think that the stock is not
valuable and thus are unwilling to pay
much for it.
Linn’s low Price to Book ratio reflects
Price to the fact that investors do not value the
1.063 N/A N/A
Book company much higher than its book
value.

Investment Opportunities
stability-oriented strategy
Linn uses commodity price and interest rate hedges to mitigate the risks of the
highly volutile oil and natural gas prices and the fluctuations in interest rates.
As a result, Linn has enjoyed positive cash flow even during the recent periods
of low or even negative net income due to the struggling oil and gas industry.
This strategy has afforded Linn a greater amount of stability during downturns
as compared to other small independent oil and gas companies without a
hedging strategy that struggled during the recession.

undervalued stock and constant dividends

Linn is an attractively priced company, as it is currently priced at 25.76 with a
P/E ratio of 4.42 as compared to the independent oil and gas industry average
ratio of 18.80 (Yahoo Finance). Further, regardless of economic climate, Linn
has consistently continued to pay dividends since 2006.

forward looking acquisitions

Linn has recently acquired several long-life oil and natural gas properties with
an eye towards predictable, long life, low-risk investments. Their diversified
properties, including acquisitions in the Permian Basin in Texas and New
Mexico in 2009, suggest a reliable stream of income for the future. The
Permian Basin is known as one of the largest oil and natural gas producing
regions in the United States, and Linn's assets in the area amount to
approximately 21 Million Barrels of Oil Equivalent of proved reserves.

management team and long-term incentives

Linn's executive team is composed of seasoned veterans of the oil and gas
industry, including founder and former chief executive officer Michael Linn, who
is now executive chairman of the board and currently serves on the board of
numerous respected oil and gas organizations, including the National
Petroleum Council and American Exploration and Production Council. Mr. Linn
like many of Linn's executives, has nearly three decades of experience in oil
and gas. His continued involvement in the company following retirement from
the role of CEO has been a model for the Linn's management, as his departure
has resulted in a number of in-house promotions. This continuity within Linn's
management seems to be a strong point of the company. Further, Linn ensures
firm loyalty with its "Long Term Incentive Plan", where executives are paid
bonuses in the form of restricted unit grants.

Investment Risks
limited customer base
In 2009, Linn's three largest customers collectively made up 56% of the
company's sales. This reliance on a small customer base is a potential risk for
Linn, especially in the case of another credit crisis.

environmental concerns
In March 2009 and February 2010, the EPA issued cease and desist orders to
Linn regarding violations of the federal Clean Water Act. While these orders
seem routine in the Oil and Gas industry and are not especially concerning,
complying with these orders may result in unforeseen costs in the near future.

hedging downside
While there are clear advantages to Linn's hedging strategy, it does mean that
Linn does not stand to realize the full benefits of increases in oil and gas
profits. Though the US Energy Information Administration predicts some price
volatility in the near future, it is predicted that the industry will recover in the
next two years as the economy regains strength and oil consumption increases
again. Linn has forgone some potential profits from this possible recovery in
favor of security.

Investment Recommendation

We recommend Linn as a buy. Despite several valid concerns regarding Linn,

we feel that their commitment to a risk-mitigating strategy, which has proved
to be effective in the past, makes them an attractive bet within the historically
volatile oil and gas industry. While Linn stands to profit from the predicted long-
term recovery of the industry, as they have secured a number of diversified
and long-life properties, we feel that Linn's conservative strategies make them
a stable company in the short term as well. Linn, though a young company, has
weathered the recent recession and downturn in oil and gas prices and, under
the leadership of a motivated and seasoned executive team, seems poised for
future success. Nevertheless, Linn currently appears to be undervalued,
making it both a relatively safe buy and a potentially profitable one.