How A Verdict In The Gulf Oil Spill Trial Will Actually Benefit BP And Transocean

| About: BP p.l.c. (BP)


Both BP and Transocean trade well below their pre-spill levels.

Even the maximum penalty would be far less than the loss of market value.

Plus, there exists the possibility that the penalty will be less than the maximum.

In the immediate aftermath of the 2010 rig explosion in the Gulf of Mexico, both BP (NYSE:BP), the operator of the rig, and Transocean (NYSE:RIG), the owner, sank as if they were going out of business. As the ensuing cleanup proceeded, both stocks gradually recovered.

Still, neither stock has reclaimed the level it traded at prior to the spill. Before the rig explosion in early 2010, Transocean traded for $90 per share, and now sits at $38. For its part, shares of BP were at $60 per share, and now trade for $47 per share.

Obviously, both stocks are still well below their pre-spill valuations because of the lingering uncertainty that exists. Specifically, the ongoing civil trial threatens to saddle BP with potentially billions of dollars' more in legal fines.

The market is clearly unwilling to award BP with valuation multiples on par with its competitors. But while investors might be fearing buying these names with the threat of billions in legal penalties, I would argue that both companies will actually benefit greatly from a resolution of the trial.

Valuations remain compressed

BP trades for 5 times enterprise value to operating cash flow and 1.1 times book value. This is a significant discount to its peers in the integrated oil and gas space. For example, Exxon Mobil (NYSE:XOM) trades for 7 times enterprise value to operating cash flow, and 2.3 times book value.

Meanwhile, Transocean is valued at 5 times enterprise value to cash flow and 0.8 times book value, while peer in the offshore drilling industry Seadrill (NYSE:SDRL) is valued at 12 times enterprise value to cash flow, and 1.7 times book value.

Investors are clearly worried about the penalties that will be levied on both companies once the civil trial concludes. Several media outlets have reported that BP could face as much as another $18 billion in damages to be paid to the U.S. under the Clean Water Act. The costs could be less, if the verdict goes in BP's favor that not as many barrels of oil spilled as have been stipulated.

While $18 billion is surely a huge sum, it's actually far less than how much market value BP has lost since the spill. Based on its approximately 3 billion shares outstanding, BP still trades for about $13 lower than its level before the spill. That means BP has lost $39 billion in market value, more than twice the maximum amount of possible civil penalties the company faces.

Above all else, the market loves certainty

Once the ongoing civil trial concludes, BP and Transocean investors will be given the gift of certainty. Afterwards, both companies will finally be able to put the issue behind them, and the market will be able to value them properly for their business prospects, without the overhanging threat of legal penalties.

Plus, there remains the possibility that BP will not be found grossly negligent, or that fewer barrels of oil spilled into the Gulf than the $18 billion penalty figure assumes.

Even if BP is hit with the worst-case scenario, the market is overly discounting the stock. Once the trial finally concludes, BP's and Transocean's investors will be able to move forward. In the meantime, it's worth noting that both companies pay their investors well to wait. BP and Transocean offer dividends that yield 5% and 7.7%, respectively.

The bottom line is that while the headline financial figures are staggering, there's a gap between how much both companies' market values have been hit since the crisis. In the end, certainty can be a very valuable catalyst.

Disclosure: The author is long BP. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.