BP’s new head, Robert Dudley, has not gotten off to an auspicious beginning. In fact, he begins his initiative with two large financial blunders, a term we do not take lightly.
The announcement of a possible dividend re-instatement, coincident with a disclosure of up to $30 billion in asset sales, hardly makes economic sense. BP announced the asset sales would bring production down approximately 8%. Why they believed investors would welcome a partial liquidation with part of the proceeds used to pay a dividend makes me wonder who was advising them. BP has, for years, paid a large dividend while buying back large quantities of its stock. It hasn’t worked. Why they felt the need to announce a possible dividend resumption, which could only lead to disappointment if the event does not take place, is odd, especially given its timing.
BP management should not even think about a dividend until it is relatively certain of its final liability—and that will take some time.
The ultimate bill is far from certain; with some 1500+ claims coming in a day and additional penalties (i.e., Clean Water Act, negligence) not included as part of the Company’s current estimate, it remains to be seen how large the total cash outflow might be. Having seen too many asbestos manufacturers believe they had the credit strength, only to file bankruptcy, is a lesson in long-tail claims.
Over the last 8 years BP has repurchased approximately $46 billion of its shares and paid $61 billion in dividends. And as the chart below shows, the $107 billion spent on “rewarding” shareholders has not worked to the investors' favor. As I have long claimed: buybacks and dividends are not the means to maximize value, nor are partial liquidations, when better solutions exist.
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The second error is thus one of corporate finance and the means to fund the spill cleanup and claims payments. The Company erred by not funding the liability with a share raise of 500 million shares. This potential approximate $19 billion raise, combined with the $10.3 billion in dividend savings, sale of future production into the forward markets, with balance sheet leverage, would enable the firm to hold onto valuable cash producing assets competitors are vying for in a world of tight energy supply balance.
BP was very efficient in its latest quarter, despite a higher tax rate emanating from the reversal of deferred tax liabilities. The past quarter’s cash flow benefited from a drag-out on trade payables and lower capital spending, acts which will undoubtedly continue. Its pension fund remains underfunded, although it might now take until 2011 for it to be recognized. Cash benefits are running 3:1 over contributions, the plans were underfunded going into the current fiscal year, and their investment assumption (7.3%) and discount rate (5.8%) are not in touch with reality, which the Company disputes.
All in all, while today’s first half financial results are good for creditors, shareholders can expect lower free cash flows had the high cash flow producing assets been held. It was in shareholders' best interest to see its free cash flows grow through higher amounts of invested capital, even if it meant some initial dilution. Once the free cash flow improved, it could have mopped up those extra shares.
And so, barring some large jump in the price of crude, BP shares are fully priced.
Disclosure: No positions