One has to admit it. What is susceptible of getting worse, will likely do it.
The CDS of BP rose on Wednesday from 260 to c400, which implies a 20% probability of default in a company that generates a $40bn EBITDA. BP, Anadarko, Transocean have lost c49% of market cap. Those, like me, who thought the first 20% as overdone, were wrong, and it’s worth mentioning why.
1. The spill is larger and taking longer to solve than initially estimated by top geologists and analysts from the industry, or Energy and Capital to Wood Mac. The press is now happy to take the largest figures for liabilities out there, clean-up costs and other risks, up to $35bn. Even if the figure looks too high based on all previous precedents (Exxon paid only $500m in damages from the Exxon Valdez), it is an undoubted risk that no one can clearly identify. And BP, let’s face it, is not Exxon in terms of agressiveness and PR concerns.
2. On the other hand, the decision to install a 24h webcam in the BOP was, in my view, a strategic mistake. Analysts, media and investors are watching this reality show every minute and it doesn’t calm nerves, while making people provide new theories of the magnitude of the spill.
3. Reputational damage on a company that has been branded as a key investment in sustainability funds, sold itself as the “greener” alternative to Shell, and which traded with a “Management Premium” to peers. The capitulation trade of most of these investors has just started, having bought agressively the stock on dips ahead of the failed Top Kill, Junk Fill and clampings.
The two areas that concerned investors the most were the maximum clean-up cost and liability that the company will pay and the security of the dividend. Tony Hayward, BP’s CEO, is not as drastic as Lee Raymond, ex-Exxon CEO, and in BP’s conference call last Friday he was vague and diplomatic. BP trades at a 10% dividend yield 2010, but the market clearly discounts this will be cut either because of political pressure (BP is, and has been always very conscious of this), or because of accounting prudence (if they pay the dividend + a provision for damages of $10bn they will exceed their 28% net debt to equity target)
Technically BP is doing what it can, recovering 15k barrels a day, but the reputational damage on the “green big oil company” is making the stock trade below Book Value and $3/barrel for its resources even if we asume zero value for its US business and a $35bn liability. All of it doesn’t make the stock a buying opportunity, and that’s where analysis has been a mistake. It is impossible to assess now which equity multiples are valid because the uncertainties are enormous. It is also fundamentally challenging to short a stock that trades below 5xPE unless we consider bankrupcy… But even in the case of mass liabilities, BP’s peers will be eagerly awaiting to take over the assets (TNK in Russia, Azerbaijan, Irak, even Amoco are highly desirable assets). Does it make ita takeover candidate now? No. Big Oil is similar to a cartel, and they will help and wait before even hinting at corporate action.
The spill will likely last til August, and BP will pay for all claims in ten-fifteen years time, after strong litigation and numerous lawsuits, but the economic implications will be difficult to assess short term. In the meantime, catching a falling knife no matter what fundamental calculations are made is a very risky job. And too many long term investors and pension funds have been at it recently.