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Greetings! I am a professional investor, with substantial experience investing in equities and distressed debt in a hedge fund capacity.
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  • Why BP and RIG are probably good longs - 6/12/10 0 comments
    Jun 20, 2010 1:45 PM | about stocks: BP, RIG
    Controversial, but why $BP is probably a good long here. It's all about probabilities. First, let's discuss $RIG. Anyone following my calls made on $RIG probably know that it probably will fair well under most scenarios. Why? They have limits on damages resulting from rig explosion due to arcane US laws. Now, I often hear in the marketplace "these laws will be turned over, or repealed." Really? I don't know about that. The law is the law, and the US has a long history of honoring law and contracts. Secondly, and perhaps more importantly, $RIG is indemnified by $BP for all spill related costs. As the CEO has mentioned numerous times, unless $BP chooses not to honor contract law, $RIG won't be net out of pocket for these cleanup costs, nor the loss of business liabilities that could arise. I make my living on contract law by being a market participant. If a corporation promises me something in writing, I expect them to make good. If not, I'll sue them. That's not fun, nor cheap, but that is the system. The one caveat is that the public market has not seen the actual indemnification language in the contract (as far as I know). But the $RIG CEO has made his stance and interpretation here very clear. Note: This was also disclosed in the 10Q in very clear language. Where could this go wrong? If the BOP is found to be defective, and if it is defective through gross negligence or criminal conduct. I have a few friends (only a few... :-) that are lawyers, and all say in all circumstances, these are VERY HIGH thresholds to prove. They've cited numerous cases where it is very difficult to prove. I have a hard time believing that $RIG was grossly negligent. Certainly not criminal... it just doesn't make sense on all fronts. Okay, so this is the Achille's heel of the long $RIG call. So that is $RIG liability. Let's not forget the operations portion, and what the moratorium means in terms of cash flow. Clearly the moratorium is hurting all drillers. I believe, because of jobs and US oil supply, that it is not in the best interests of America to keep this moratorium. It is clearly a political ploy by extremists (both left and right) to push Obama. These issues fade with time. The comparison to Katrina is flawed on so many levels that it is not even worth discussion. In the end, I don't think there will be a 12 month moratorium (as discussed by the brilliant $GS analyst covering the sector), and won't even be a 6 month moratorium. Anger will dissipate, the focus will be the economy, and keeping jobs growth and oil prices low. Which brings me back to $BP. The recent bankruptcy rumor in the market place 2 days ago, I believe, was engineered by traders and circulated for a nice, quick, profitable trade. How did they do this? Buy protection, buy puts. Get a few other actors involved. Seize the moment where anti $BP rhetoric is high, and push it even further. Create fear. Sell puts and close CDS positions for a quick profit. Go watch the World Cup. It's that easy. (Well probably not that easy, but not difficult to do when playing off of fear.) Fear and greed are the undoing of investors. Always. Now, a few things have happened since then that give investors hope that the worst is behind $BP from a TRADING standpoint: 1) Bankruptcy fears have hit the name, CDS blew out, and now has contracted. Could anyone come up with a better downside scenario, and have it abate? No. That's about as bad as it could get. Bankruptcy would suck, and those with fresh memories of Lehman, Bear Stearns, etc. don't want to be caught in nonsense like this. There is a huge difference that these comparisons overlook. Lehman, Bear, and others had low quality (uncertain quality?) assets. $BP, on the other hand, has top tier hard assets that are worth a mint or two. Anyone would love to have their choice, cherry picked assets. So, go buy the debt, at the very least, if you can. CDS is already contracting. The company has low leverage. It's the furthest thing from a bank. As a matter of fact, all the things that make banks weak investments in this environment are the things that make $BP strong and desirable. Bottom line: $BPs operations are largely intact, and the company produces solid cash flows with high quality assets. 2) UK Gov't involvement is key. Now the the UK gov't has stepped in to protect BP, Obama's rhetoric will receive int'l pressure to stop cracking the whip on $BP. Media is circulating that 1/6th of orphans, widows, pensioners, and lepers collect $BP dividends to make ends meet. I personally don't buy the number, but the concept/model holds true. The UK gov't will do everything it can (gingerly of course), to protect $BP, as it is a national champion. They have, effectively, said enough is enough. Bottom line: $BP now has political will supporting it, albeit from the UK. 3) The dividend discussion is almost a non-issue at this point. If it doesn't get cut, great, upside. The stock is yielding 10%+. That's nice to have in a portfolio where the world is going crazy, and no one knows what the next short term moves are. If the dividend gets cut, much as the market is pricing now, we may see a little dip in the share price, but only a little. The stock has much bigger issues than the 2Q and 3Q dividends. Bottom line: Dividend is is the leaves of the tree. Step back, take a look at the tree. If possible, step back and take a look at the forest. 4) There is an end in sight for putting the larger cap on the well, and capturing most, if not the flow. This could stop the bleeding, and allow the focus on remediation and cleanup. 5) This point, perhaps the most important, is what is this going to cost $BP in terms of liabilities. There are several types of liabilities. a) Loss of the RIG - This is covered by $RIG and not $BP (unless, once again, this is found to be criminal/grossly negligent). b) Cleanup & Remdiation costs - $BP has vowed to pay for all cleanup costs, and market should believe them. How much could this be? A few billion dollars. Let's say $5 BN. To date, costs on this front have been about $1.5 BN. Personally have a hard time seeing this triple, but let's be conservative. c) Compensatory Damages (Loss of jobs and lost revenue due to moratorium) - This clearly should not be a $BP liability. This came about from government action, and not $BP. I find it very unlikely, and hard to believe that $BP will be on the hook for a gov't imposed moratorium. The proximate cause (legal term - en.wikipedia.org/wiki/Proximate_cause)for foreseeability is nearly impossible. It's basically saying $BP should have known that a blowout would cause 6 months of total loss of revenue/wages for all deepwater rigs in the GoM. Really? Please, let common sense prevail here. d) Punitive Damages - This is the worrisome part of the liability situation. If the US gov't looks to punish BP, this is where it comes from. Estimates range from $8 to $12 BN. If Exxon Valdez (adjudicated in by the US Supreme Court!), it is 1:1 on compensatory damages. Could it be more? Not if someone is willing to throw out a Supreme Court ruling. (Wasn't the Exxon Valdez captain drunk? Wouldn't that be considered criminal/grossly negligent?) e) Loss of tourism - Sketchy that $BP will be on the hook for this. There is no law that requires them to pay for all of this. I think $BP will pay something nominal. But this is getting out of hand. Tally it up. $CS comes out with $40 BN. That's high. Given the loss of EV to $BP, it's nowhere near that. A few other things: these losses are tax deductible, and they will be paid out over many years. I have a hard time analyzing the market volatility on the stock -- it's nearly all emotional. But I can do the math -- it's nearly all rational. Having said that, $BP might be a buy of a lifetime. The downside is pretty low vs. upside. Lose 10% to make 40%? Sounds like a bet to me. Last point: I bear no love for $BP. I bear love for making money. I truly think the way $BP cut corners and put pressure to do things on the cheap is reprehensible. But that's all emotion. And emotion has not place in long-term, thoughtful investing.

    Disclosure: Long RIG
    Themes: GoM Stocks: BP, RIG
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