Jun

7

An analyst on CNBC yesterday was saying BP is cheap, and the dividend is secure. His interviewers (are they supposed to have an agenda of their own? Or is this just asking the tough questions?) kept hammering on their idea that it will be politically unacceptable for BP to pay dividends to its shareholders, a line of questioning that drew uncomprehending stares from the analyst.

George Parkanyi comments:

Yeah that makes sense… take a whopping out-sized risk on BP with its huge potential future liabilities, in a world economy and market possibly on the brink, where P&G can lose 35% of its value in 10 minutes, for a dividend. Where do I sign up?

Rocky Humbert comments:

Here are some questions that one might consider before investing in BP. (No such analysis is required for a skilled trader who claims to be able to systematically buy low and sell high without regard to "fundamentals.")

1. Remediation costs and liability are related to a spill size both by physics, practice and statute. The Exxon Valdez had a defined amount of crude. How much crude will spill from the Deepwater Horizon?

2. What is the law regarding punitive damage penalties if gross negligence can be proven? Is it like a RICO case (4x)? Is it capped by statute? Or can it be unlimited (like an old Joe Jamail lawsuit)?

3. What is the law regarding punitive penalties if there is criminal liability? What is the worst case penalty? If the Goverment files an criminal indictment, what effect(s) will have on their business?

4. What effect will the overhang of litigation have on the cost of BP's financing of their regular business? If there is a risk of a $50+ Billion punitive penalty, what will the credit rating agencies do? And if BP's cost of financing increases by 100-300 basis points, what effect does that have on their exploration budget?

5. If they capped the well today, can one assess the risks of #2, #3, and #4 with certainty?

6. What is the risk/cost of a boycott of their service stations? Did Exxon experience a boycott? And if so, what impact did it have on their downstream operations?

7. What is the tail (in years) of the litigation? Will they be required to post a performance bond? And if so, what assets will they sell to meet the performance bond? More generally, is there a risk that they will have to sell assets to meet other liabilities? Or, can they almost certainty meet the expenses out of current cash flow?

8. How is BP's stock faring versus other companies with exposure (Anadarko, Cameron, etc.)? Will these companies present a unified defense? Or will they be pointing fingers at each other — further concentrating the litigation risk?

9. How has BP's stock performed versus other major oil companies? For example, if BP is down 35%, but Chevron,Exxon,Conoco are also down 15%, which of these companies represents the best relative value, given the facts and probabilities?

10. If I am leaving for a five-year vacation, would I be comfortable purchasing BP at the current price, and not looking at it until I return? Is there any price where I would buy a non-trivial amount of BP and not look at it for five years?

Vince Fulco writes:

While I am no apologist for BP's seemingly high risk and perhaps incompetent procedures in the Gulf, I am also wondering about the proportionality of the public reaction (to the stock that is, not the beach pollution) vs. the total cost of the disaster. The company's mkt cap is down $70B since the explosion and is currently $115B for a company with $230B-ish in historical assets ($90B estimated in the US) and relatively low non-current debt levels. Moreover the company has a stand alone re-insurance company with $3.5B in assets. They may also have some additional cover which I am disregarding for now. As Ken has stated, halting the dividend brings $7-10B more to pay claims which I assume will have a somewhat long tail, say 3-5 years. And just because Chuck Schumer believes the payout should be halted, doesn't mean he knows anything about corporate finance strategies or management's responsibilities to its owners. More evidence of the worrying 'they came for…' behavior.

Given the rarity of the event, arguably the next comparable disaster naturally might be the Exxon Valdez (other smaller events could be chosen too). The best numbers I could find were a cost of roughly $5-7B stretched out over 20+ years. For argument sake, let's say the cost to BP is 10x as much or $50B; that would be roughly 1.6-1.8x mean operating income of the last 4 years.

I am not considering BPT in the conversation because it is a different animal and Rocky has addressed it well. Lastly, since our current admin seems to be in the business of picking winners and losers, are they ready to and can they kill a formerly $1/4T asset company 40% held by pensioners and retirement funds of our closest ally? It is also notable that LA's governor is already publicly complaining about the effect on jobs if a drilling ban is instituted for any length of time. Double edged sword indeed.

Disclaimer: This is absolutely not a recommendation for anyone but I am long right at these levels and would appreciate reasoned arguments against.

Rocky Humbert adds:

One more thought on BP as I work through their financials: The company generated free cash flow of about $7 Billion last year and paid $10.5 Billion dividends.

Their next dividend will be announced on about July 27th with an ex-date of 8/4/10. Looking at the pricing of at-the-money options, it appears that the market has priced in a cut of their dividend by 50% (from .84/share to about .44/share).

Any spec-lister who has a variant perception on their dividend policy (either holding it at its current level, or reducing it more than 50%), can execute an direction-neutral options "conversion" to express this view.

In my humble opinion, a 50% cut in the dividend seems entirely reasonable to satisfy all of the different constituencies. And, in assessing the future behavior of the stock, one needs to consider that Mr. Market has already discounted this news.

Before you invest in BPT, I suggest you get an objective estimate of the reserve tail in the Prudoe Bay field. I studied this several years ago and there is a NAV based on the dwindling reserves and foward curve in the crude market at various discount rates.

The field should start tailing off in 2011 or 2012 and the stock will be worthless certainly by 2020 so you need to value not only the current and future crude price but also the decline rate. I'd also suggest that you look at their financing and change of control provisions as well as cross default issues. Lastly, I owned BPT when it was at a substantial discount to its NAV at a large discount rate (versus crude futures), but could not short it when it went to a large premium because the shares could not be borrowed.
 


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