Sorting Out PetroChina's Trillion

PetroChina Co. (PTR) Monday vaulted past Exxon Mobil Corp. (XOM) to become the world's largest company based on its market capitalization, but the record entry for the oil and gas producer should be buried in asterisks, questions and deep concern about the Chinese stock market.

By one measure, Petro-China is valued at about US$1-trillion after its shares more than doubled in value during their first day of trading in Shanghai Monday. But if you think that investors actually own US$1-trillion worth of the company's shares, justifying the company's market cap, think again.

This is a government-controlled corporation -- a communist government at that -- which means the number of shares actually available to investors is small.

For example, the newly listed shares on Shanghai's domestic market represent just 2.2% of the company. China National Petroleum Corp., the state-owned parent, still owns about 86% (PetroChina had previously listed 12% of its shares in Hong Kong and New York).

"We have such a hard time sorting out those kind of government-dominated companies," said Henry Groppe of Groppe, Long & Littell. "We don't really know what they include, or not include. They're just extensions of the government and therefore very hard to analyze and establish the boundaries."

Indeed, the market cap is downright theoretical, based on the value of the surging Shanghai shares. Would PetroChina still be valued at a trillion dollars -- or about US$500-billion more than Exxon -- if the value of the Hong Kong shares were taken into account or if all of Petro-China's shares were floated?

No way. The soaring share price reflects two manias: one for China and another for oil. Combine the two, add in the relative scarcity of shares available for investors to buy, and you have sheer lunacy for a thin slice of the company.

Warren Buffett, undoubtedly the world's most respected investor through his holding company, Berkshire Hathaway Inc. (BRK.A), recognized this. He dumped his remaining Petro-China shares in October, fearing that they had risen too far, too fast.

Why? Despite China's strong economic growth, PetroChina is just a commodity producer, and one that does not benefit from China's growth any more than, say, Exxon does. Yet the Chinese company commands valuation multiples that put it in a league with an entirely different class of companies.

For example, comparing PetroChina to Exxon makes the former look like a high-flying Internet stock. According to Bloomberg, the two companies have similar oil and gas reserves of more than 20 billion barrels. Although PetroChina's reserves have been growing faster, at a 5% pace, the company's revenues are just a quarter the size of Exxon's.

Also, PetroChina's shares trade at a head-spinning 55-times earnings, versus just 13-times earnings in the case of Exxon. That ludicrous multiple puts PetroChina's shares in a league with Google (GOOG), a technology and advertising firm whose growth prospects are far more enticing to investors.

It appears as though Chinese-produced oil is somehow more valuable than U.S.-produced oil -- an inexplicable difference made more baffling by the fact that Chinese companies have a hard time expanding through foreign acquisitions as countries erect walls to Chinese ownership.

"This is a big company and it produces cash flow, so it's not a scam," said Alex Ruus, a fund manager at Northern Rivers Capital Management, which includes an energy fund. "But there is a lot of speculative investing in China right now, so I would suggest that this is a carry-over of the Chinese stock market bubble."

PetroChina was the first company to ring the trillion-dollar bell. But it is hardly the world's reigning company.