It looks like BP's (NYSE:BP) legal troubles regarding the gulf oil spill are far from over. Recently, the company has paid $4 billion to settle criminal charges, but it risks paying another $17 billion in the coming months if it loses a civil trial which will take place soon. BP is being blamed for violating Clean Water Act and if the company is found guilty, it will have to pay the largest environmental fine ever imposed to a company in the US if not in the world.
In the criminal court, the company was found to be negligent; however, it can now be found "grossly negligent" which will potentially maximize the amount of fine BP can be ticketed for. In this case gross negligence specifically refers to: "tantamount to wanton and reckless behavior, or conscious disregard for reasonable care that is likely to cause harm or injury." Furthermore, the amount of oil that was spilled in the gulf will also be assessed for an accurate measure, which will play a large role in determining the size of the bill that must be paid by the company. If BP was found to be negligent but not grossly negligent and the amount of spilled oil turns out to be limited, the company will end up paying around $4-5 billion as opposed to paying up to $17 billion if it was found to be grossly negligent and the damage assessment turned out to be worse than expected.
Until last week, BP was in talks with the government in order to reach a settlement without taking the issue to a trial. While we don't know the specifics of the negotiations, it seems like the government asked for a bill BP was not willing to pay; therefore, the issue is taken to the court.
BP sold a lot of oil generating assets and became smaller in order to pay the fines and rebuild itself as a new company. During this time, the company's market value fell from $191 billion to $86 billion, which later on recovered back to $130 billion, but still far from the levels seen before the accident in the gulf. As the case keeps going on, this adds to the uncertainty, which hurts the investors of BP. In fact, unless a last minute settlement is reached, it might take years before a court decision is made. The lengthy process might make the company's investors even more nervous.
BP has already pleaded guilty last year when it faced 14 different criminal charges. Now the company is likely to argue that while it is guilty of negligence, other companies involved in the accident such as Halliburton (NYSE:HAL) and Transocean (NYSE:RIG) should also carry part of the burden with BP. Basically, the company doesn't want to pay the entire bill by itself when other companies might have been part of the blame. If multiple parties are found to be negligent in the case, it can't be ruled as a "gross negligence" because more than one party would be sharing the blame. Usually gross negligence is ruled when only one party is responsible for the entire damage because this means the effects of one party was large enough to cause the damage by itself. If multiple parties are involved, then the effect of each party cannot be large enough to cause the entire damage by itself, which can effectively reduce the charges. The government can always argue that BP was in charge of the project even though the project was completed by multiple parties; therefore, BP is responsible for all the damage. This will be interesting to see.
Currently BP has $15 billion in cash and equivalents in its balance sheet. The company has settled a charge with the government for $4 billion, spent $14 billion for direct response and clean-up and $10 billion was allocated for the local governments and businesses who got harmed because of the oil spill. Given that the trial is likely to take a couple years, BP will be able to save more money by generating more cash flow and selling more assets if needed. Because BP is currently in a positive cash flow status, the company can easily pay any fine that's less than $15 billion. For payments above this number, BP can always sell more assets or come to terms with a long term payment plan.
Furthermore, I don't even think BP will be charged with "gross negligence" in this case. First, there were multiple parties responsible for the leak and gross negligence can only be assumed if one party is responsible for the entire damage alone. Second, the Department of Justice will have to prove without a doubt there was a willful misconduct leading to the accident. This is very difficult to prove because there has to be solid evidence or clear confessions from the side that is being blamed. Without BP's cooperation, it will be very difficult to obtain evidence of willful misconduct on the government's side. Third, BP claims that the government has grossly overstated the amount of oil that leaked in the ocean because more than 20% of the oil was captured by BPs safety measures before it even made it to the ocean. The amount of fine will be directly related to the amount of oil that actually leaked in the sea.
BP is expected to earn $5.39 per share this year and $6.15 in the next year. Even if the company uses up all its cash reserves to pay the bill, it will still be undervalued because it is looking at a forward P/E ratio well below 10 with its current share price of $41. The company's current dividend yield above 5% makes it easier to wait for the investors while the court takes its time to make a decision regarding the issue. I don't expect BP to lower its dividend rate anytime soon because the company's current earnings can easily support the current dividend rate with a payout rate below 50%.
For the patient investors, BP looks like it has good valuation. I am currently considering initiating a long position with the company. BP is currently a new company after learning a lot of valuable lessons. Before, the company used to put too much focus on profits while forgetting everything else, but now the management realizes that BP can't be profitable if it uses all its earnings to pay fines and court charges.
I can see BP paying $5 to $10 billion to the government and moving on after the court decision, which should come in a couple years. After that, as long as the company doesn't have another similar incident, it will continue to be a cash cow, and will continue to be a good investment.
Disclosure: I am long HAL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.