Shares of Anadarko Petroleum (APC) took a serious beating on the final trading day of the past week. A judge ordered the company to pay anything between $5.2 and $14.2 billion related to past cleanup liabilities, causing a big sell-off as the company itself and investors were unprepared for such a big fine.
Friday's correction, which came on top of a wider correction over the past month, combined with past estimates for the potential claims has resulted in the fact that the market has priced in the most of the bad news. In case the stock were to sell off further in the coming days, it might be worthwhile to pick up some shares in the $70-$75 price area.
A Big Negative Surprise
As is well known, Anadarko has been involved in a long-term lawsuit regarding the environmental and legal liabilities related to the 2006 purchase of Kerr-McGee.
Rather than making a deal, the company sought to fight the cleanup liabilities case in court with some devastating consequences. According to judge Gropper, Anadarko now has to pay awards between $5.2 and $14.2 billion. According to the judge, Kerr-McGee and subsidiaries are liable for fraudulent transfers related to the 2005 spin-off of the titanium dioxide business. The actual amount which the company has to pay depends on the offsetting claims which it can show in the Tronox bankruptcy.
Note that this is equivalent to roughly $10-$28 per share, and is far greater than analysts' estimates for a $3 billion liability, or around $6 per share. As such, the negative surprise amounts to $4-$24 per share.
The Background Information
Back in 2006 Anadarko bought oil and gas producer Kerr-McGee in a $16.4 billion deal which in hindsight is proving to be very expensive. In 2009, the company faced a lawsuit which unfortunately enough for Anadarko was related to the liabilities of the chemicals business which has been spun off as Tronox (TROX).
Under the lawsuit, the US government sought some $25 billion to restore polluted sites and compensate 8,100 claimants.
The judge now believes that Anadarko and Kerr-McGee acted with "intent to hinder" when Tronox was spun-off. Tronox went bankrupt on the back of the liabilities as a consequence of past legal verdicts, and the judge believes this transfer of liabilities to Tronox was unlawful.
Obviously this is not a great spot to be in for Anadarko and its shareholders, as uncertainty will continue. There is still much unknown regarding the actual amount which has to be paid, the process to appeal, settlement options, and tax deductibility of the awards, among others.
Anadarko notes that the judgment from Friday is by far not the last judgment, as the court has ordered both parties to submit further briefings in the coming 60 days. This will be followed by another judgment which is subject to appeal.
Despite the announcements, the uncertainty and legal overhang could last for years.
CEO and Chairman Al Walker commented on the outcome of the verdict, "Given the significant factual evidence supporting our position, we vehemently disagree with the judge's memorandum of opinion, and we fully expect to pursue every avenue available to us through the appellate process to protect the interests of our stakeholders, once a final judgment including damages has been rendered."
Anadarko furthermore argues that the judge did not have the authority to issue a judgment, as federal bankruptcy courts have limited power over these kind of lawsuits.
Anadarko reported its third quarter results at the start of November. Cash and equivalents stand at $3.94 billion. Total debt stands at $13.65 billion, for a decent net debt position of $9.7 billion.
Revenues for the first nine months of the year came in at $11.24 billion, up 12.4% on the year before. Earnings came in at $1.57 billion, down 28.2% on the year before. Note that earnings in the comparable period of 2012 saw a nearly $1.8 billion boost on the settlement regarding taxes in Algeria. At this pace, revenues could come in above $16 billion, with earnings seen above $2 billion per annum.
Factoring in losses of about 6.5% on Friday, with shares trading around $78 per share, the market values Anadarko at $39 billion. Friday's correction reduced the value of the firm by some $2.7 billion.
The current valuation values equity in the business at 2.4 times annual revenues and roughly 19-20 times annual earnings.
Anadarko's quarterly dividend of $0.18 per share, provides investors with a dividend yield of 0.9%.
Some Historical Perspective
Long-term holders in Anadarko have seen impressive returns, driven by solid production growth. Shares have steadily risen from levels around $25 in 2004 to a peak around $98 per share by the end of October. Ever since shares have seen a 20% sell-off to current levels at $78 per share, while shares are still up some 5% year to date.
Between 2009 and 2013, Anadarko is set to increase its annual revenues by a cumulative 80% to levels just above $16 billion. Earnings have been extremely volatile on the back of many incidental items, but underlying earnings have been increasing steadily to levels north of $2 billion this year.
The implications for Anadarko could be severe. Friday's drop in its market value is about $2.7 billion, which comes on top of the settlement amount being priced in by the market already. Analysts already guided for a total cost of around $3 billion, more than double the estimates of the $1.4 billion as estimated by the company itself.
As such, the market has already priced in a $5.7 billion loss, which compares to the ordered payments of $5.2 to $14.2 billion. If a payment of $10 billion were to be awarded, a great deal of the losses are already priced in at $5.7 billion. Note that Anadarko potentially could furthermore be able to forfeit payments, delay those payments or will be able to deduct future earnings from these losses.
Even in such a case a $10 billion payment could boost the net debt position towards $20 billion is too high for Anadarko and would most likely result in asset divestitures. With competitors knowing the company has to sell, many asset sales are a bad sign as they could occur below fair value. Note that Anadarko already recently announced a $2.6 billion deal to sell a 10% interest in its Mozambique operations, with those proceeds not being factored in yet.
The remaining stakes in those assets or in Brazil could be necessary to drive down the debt position. In case the fine being awarded jumps towards $15 billion the company might be in "play", otherwise divestitures will most likely be sufficient to guarantee Anadarko's stand-alone future. Anadarko has taken a lot of bad publicity in the wake of this news for not settling the case. This has now resulted in a much higher fine than a price at which parties could potentially otherwise have settled for.
Back at the start of November when Anadarko reported its third quarter results, I last took a look at the company's prospects. I concluded that the company was showing solid growth, but this came at a price. Strong production growth, with an increasing focus on production in lower risk areas is Anadarko's new strategy. Besides the US shale plays, Anadarko also sees the first production of the Lucius spar in the Gulf of Mexico.
Back in November shares traded at $95 per share, valuing the business at 23 times adjusted earnings, which is quite a valuation premium especially given the modest dividend yield. Ever since, shares have sold off roughly 20%, reducing the market capitalization of the firm by some $10 billion. As such, the recent sell-off on top of Friday's losses already priced in a great deal of uncertainty overhanging from the liabilities.
One thing is for sure, that this thing could drag on for a while. That being said, the adverse impacts are already priced in to a great extent at nearly $6 billion, warranting the purchase of shares in a $70-$75 price range.