Some investors can't resist risk, and there are few riskier investments than a company with a unique tax profile that has announced it is exploring strategic alternatives.
Take, for example, the case of Linn Energy (LINE). The stock of the Texas-based master limited partnership is down 88% over the last year and trades for $1.30. However, since the start of the month, shares have more than tripled while experiencing double-digit swings in both directions.
In February, Linn Energy announced it had retained Kirkland & Ellis as its legal advisor in an effort to strengthen its balance sheet. Last week, the company announced it had to delay filing its 10-K this year due in part to its auditor's doubts that the company can continue as a going concern.
Oddly, the stock has rallied since the announcements, due in part to the recent surge in oil prices, and perhaps also due to similarly distressed Ultra Petroleum (UPL) obtaining waiver and amendment agreements from some of its creditors.
However, on Thursday shares of Linn Energy fell 18% following a Wall Street Journal report that the company is exploring a change to its corporate structure, which could involve merging with its affiliate LinnCo (LNCO). The change, as explained by Journal sources, would protect investors from being hit with a tax bill for debt forgiven in a bankruptcy or out-of-court restructuring.
As Linn Energy is an MLP, it does not pay corporate taxes. Instead, its shareholders -- known as unitholders -- pay taxes. For unitholders, debt forgiveness could count as noncash income. In a bankruptcy event, shareholders usually recoup none of their investment. In the case of an MLP, it would be possible that not only would their investment go to zero, they may also owe money.
Restructuring an MLP -- though Linn Energy has not confirmed that's what it's doing -- is no easy feat. In 2014, Kinder Morgan (KMI) changed its structure to a C-Corp from an MLP, which involved the roll-up of Kinder Morgan Energy Partners (KMP), Kinder Morgan Management (KMR) and El Paso Pipeline Partners (EPB) under one umbrella. As such, the exchange of KMR and EPB stock for Kinder Morgan stock created a taxable event.
"A U.S. holder of KMP or EPB will generally recognize capital gain or loss on the receipt of KMI common stock and cash in exchange for KMP or EPB units," Kinder Morgan posted in an FAQ on its site during the transition. "However, a portion of this gain or loss will be taxed as ordinary income or loss."
With Linn Energy stock down so much over the last year, capital gains are unlikely to be of much concern to long-term investors. However, investors who think they are scooping up a bargain as oil prices rise may want to sit on the sidelines.