Oil Stocks: What Linn Energy's Latest Move Means for Future Dividend Growth

By Markets Fool.com

On Feb. 23, Linn Energy , and its C-corp holding company, LinnCo , announced that they have filed paperwork with the SEC to sell as much as $500 million in additional equity, each, at market prices.There are two main reasons Linn Energy's latest financial deal might have big ramifications for future payout growth and long-term total returns.

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Short-term pain: Dilution offset by an "ATM" program
MLPs, by their nature, pay out almost all earnings as distributions to unit holders. Thus, growth must come either from selling new equity or through debt. Linn Energy's high debt load of $10.3 billion means that future growth, mainly through accretive acquisitions -- in which distributable cash flow per unit increases -- must include at least some additional equity offerings. While existing investors are diluted in the short term -- potentially by as much as 18.5% in this case-- the way the offering is structured should benefit existing unit holders in both the short and long term.

That's because the new shares and units will be sold "at the market," or what is known as an "ATM" program, which is a continuous equity offering. This approach is better for existing investors because it allows an MLP to sell large amounts of new units slowly, over time, preferably at the highest market price it can get, in contrast with the old way of equity sales in which an MLP would sell a large amount of new units, at a discounted price, all at once.

By selling additional units gradually, at the MLP's discretion, Linn Energy can prevent short-term price drops, but more importantly, it can time its equity issuances for when its unit price is higher. The same funding requires less new equity to be sold and minimizes dilution. In the long term, that means easier distribution growth -- which is the primary growth catalyst for the unit price for most MLPs.

Long-term benefit: Potentially more than $1 billion worth of buying power to grow Linn Energy's asset base
Of course, potentially selling $1 billion in new equity won't help investors much if Linn plans to simply to pay down its debt. However, I think it's more likely that management has far more useful plans for this money.

Back in January, Linn Energy announced a deal with GSO Capital Partners, an affiliate of The Blackstone Group , in which the two would form a joint venture called DrillCo. GSO will provide $500 million to drill new wells for Linn Energy in exchange for 85% of the cash flows from the new wells until it's recouped 115% of its investment. Afterwards, Linn Energy will receive 95% of the cash flow until the wells run dry. In other words, Linn Energy gets to increase its production, at no cost or risk to its own balance sheet.

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At its most recent earnings conference call, CFOKolja Rockov described the effort to strike a similar kind of private-equity deal via an initiative as what would be "a partnership similar to DrillCo but focused on acquisition funding." Rockov continued: "While we are still in the early phases of forming this acquisition partnership, we are encouraged by the concept and resulting potential benefits to Linn."

While this is pure speculation on my part, based on its recent deals and management's statements I think it might be possible for Linn Energy to use its $1 billion in new equity to fund a joint venture with a private-equity group. This might be the equivalent of a leveraged buyout of a much greater amount of oil and gas assets than it could on its own, but without actually taking on more debt.

Takeaway: The likelihood of stronger payout growth in the future when oil prices recover
Nearly all MLPs use secondary offerings to raise capital for growth, but Linn Energy's latest move, a switch to an ATM program, should benefit existing investors by preventing sharp price drops compared with when millions of new shares or units flood the market. In addition, the funds raised might allow Linn Energy to continue its successful track record of asset, production, and distribution growth through accretive acquisitions, especially considering its recent intriguing alternative financial deals with private-equity group GSO.

With oil assets now moving at fire-sale prices, $1 billion, partnered with a potential joint-venture private-equity buyout of low-cost, low-decline oil and gas properties, could fuel rapid production and cash flow growth when energy prices finally recover. That, in turn, greatly increases the probability that Linn Energy's distribution will rise faster in the future, potentially fueling market-crushing long-term total returns that make it an appealing income investment at today's undervalued prices.

The article Oil Stocks: What Linn Energy's Latest Move Means for Future Dividend Growth originally appeared on Fool.com.

Adam Galas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.