Editor's Note: Although this post mentions "British Petroleum" several times, especially in reference to Congressional efforts to distance the company from its U.S.-based competitors, the oil and gas firm officially changed its name to BP in 2001. Please be aware of the distinction.
Since the start of Deepwater Horizon disaster in the Gulf of Mexico in April, British Petroleum’s (BP) share price has plummeted over 50%. Ongoing failure to successfully cap the oil spill, clean up costs and liabilities spiralling out seemingly out of control, and with US politicians jockeying around for political capital, sentiment towards BP has never been lower. In market value, this loss is around $100 billion, and many are starting to ask if this is actually a fair reflection of impact on the company, or if it largely oversold as fear continues to outweigh the fundamentals?
This is the basis for a "Fantasy M&A" research note by JPMorgan Cazenove earlier this week, which suggests that BP has a strong intrinsic value and is still "asset-rich," despite the share price plummet. This decimation of the share price may now also make BP vulnerable to a takeover bid, given that the major players in the industry are not likely to have lost sight of the company’s underlying assets. JPMorgan Cazenove’s note has sparked a flurry of talk in the market surrounding the likelihood of a bid.
Even before the recent problems in the Gulf of Mexico, there had been some light talk in the market that a few big names were showing an interest in BP. The recent sell off has now brought about a price which may just be too good an opportunity to miss, and may act as a catalyst for those companies considering an offer to come forward. Oil industry analyst Fred Lucas, who wrote the JP Morgan research note, speculates that Exxon Mobil (XOM) and Royal Dutch Shell (RDS.A) are the two most likely candidates, mainly due to their shared business model with BP.
Exxon specifically has been suggested as a likely candidate, because of the strength of its balance sheet and its proven ability to integrate a large transaction such as this. PetroChina (PTR) and Gazprom (OGZPY.PK) on the other hand, two names which in the past have been picked up on as potential bidders, are seen as unlikely to come through with a serious offer, with significant political barriers to a move from the Chinese major, and with Gazprom suffering high debts and a low stock market rating.
A move from Exxon would not be an easy ride either, with significant anti-trust issues facing the move. Refinery overlaps particularly would come under scrutiny, with the US Government historically very protective when it comes to securing the country’s gasoline supply and distribution. Lucas believes these would not be insurmountable however, suggesting Exxon could spin-off BP’s downstream operations to overcome the overlap problems with the refining business. That said, a merger of the two would likely see a massive integration of BP’s high quality assets, with the company’s low cost liquid natural gas (LNG) assets for example, a prime target for Exxon if they want to expand their global model.
So what form would a likely bid take?
Purely speculatively, Lucas suggests the offer could be 38% cash, for $50bln, 38% in shares of BP’s downstream operations, tentatively valued at $50bln, with the remaining 24% coming from Exxon Mobil shares, worth around $32bln. This values the company at around 473 pence per share, which if compared to today’s price near 330p, shows some indication of the level the market is undervaluing BP. That said however, there is one overriding factor that would change all these assumptions significantly, and that is the true cost to BP of the oil spill is still unknown. JPMorgan is estimating the clean up liability at $33bln, but until BP can stop the flow of oil, and start to get a lid on clean up operations in the gulf, this could still really be anyone’s guess.
It is interesting consideration, at least for the duration of this crisis, that a fair valuation of the company would really need to be assessed on the basis of its liabilities (as mentioned, the full extent of which are unknown as far as the Gulf of Mexico is concerned), and much less so on the strength of the company’s assets.
There is one area that a takeover would likely have strong benefits for Exxon Mobil, the world’s largest public energy company, and that is political capital. Since the Deepwater Horizon disaster, President Obama and many US senators have come out with an absolute tirade of criticism against BP and their handling of the spill (some of which is warranted of course), emphasising the "British" in British Petroleum to disassociate themselves with the disaster.
This juxtaposition to become "lead critic" of the spill, in a large way for their own political ends, has been acting as a constant weight for BP over the past few months, one could argue stoking the fires of fear for investors, and no doubt leading to pressure on their share price which may otherwise have been, to one extent or another, less severe.
A move to takeover BP from Exxon Mobil, thanks to their strong balance sheet and experience of similar oil spill disasters, could be expected to alleviate at least some of this political pressure. The Exxon Valdez incident in 1989 would be a prime example, of course, of the company’s experience gained in cleaning up large scale oil spills. Any respite from US politicians and their media blast of BP, would no doubt allow the markets some breathing room to more accurately and fundamentally asses the costs of the gulf spill for the company.
So what could the broader impact be if we take this to the extreme, and assume a full takeover and the delisting of BP from the London Stock Exchange (LSE)?
BP is one of the UK’s largest companies, and is also one of the heaviest weighted stocks in the Financial Times’ top 100 blue chips stock index (FTSE 100), the UK leading stock market measure. Not only that, but the company has consistently provided very strong, double-digit dividends for its investors, holding one of the most significant dividend yields (until their recent suspension of course) of the top 100 companies.
The FTSE-100 is in fact, heavily weighted in both the oil and energy sector, and the mining and basic materials sector. These has meant that intrinsically, the "fortunes" of the index have been closely linked with the share prices of the major players in those sectors over the past few years, which in turn, have been closely correlated with commodity prices. This has particularly been the case during the recent financial crisis, where the UK index has shown a fairly high correlation with crude oil and base metal prices, although one could argue this also comes as the larger economic effects of the recession would effect both in a similar manner, but separately. The removal of BP from the index would go someway to decoupling the benchmark from the oil and energy sector, and we could expect to see increasing divergence between stocks and commodity prices as global economies recover.
The delisting of the stock in London would also have a profound impact on investment funds based around the UK’s leading 100 companies. With BP being such a large household name, and being so heavily weighted in the FTSE 100, its removal from the LSE would lead to a large number of funds, not only in the UK but globally, having to remove the stock from their portfolio. In the run up to the delisting, this would inevitably lead to a lot of selling pressure coming through from these fund managers, based solely on the technical need to realign their fund with the ‘new’ FTSE-100. A number of funds would also suffer because of the loss to their portfolio, of a high yielding dividend, particularly growth based funds and those funds fundamentally relying of company dividends for their return. The loss to these funds of a dividend yield of over 10%, from a major blue chip, would be significant.
Although many of the funds mentioned here would be predominantly used as investment instruments or based on a more speculative trading model (for example hedge funds and sector tracker funds), many of them will in fact, be used as ‘safer’ means of long term savings, with the classic example being pension funds. Pension funds could expect top be hit hard from the removal of BP form their portfolio, both in terms of long term growth (which BP has shown over the past two decades) and with the aforementioned loss of high dividend yields. This of course brings the wider impact away from just those who actively participate in trading stocks, but to the ‘average’ person on the street, who without knowing it, relies on BP to an extent for their savings and pension.
At this stage, all of this is just speculative of course. The chances of a takeover of BP, who would do it, and the value the company would achieve, all remain to be seen. The true cost to the company of the Gulf spill is really an unknown factor, which could shape the whole landscape for the company for years to come. In addition, US political opposition and any forthcoming legislation against oil exploration and development in the US, brought on by the recent disaster, could hit the industry as a whole in unforeseen ways.
That said, the large sell off recently based largely on fear, opposed to actual liabilities and fundamental problems with the country, certainly appear to leave it open to a takeover bid.
Disclosure: No positions