BP's Russian Divorce Battle: Will Shareholders Get Alimony?

| About: BP p.l.c. (BP)
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BP (NYSE:BP) issued a press release on June 1st, 2012 as follows:

BP announced today that it has received unsolicited indications of interest regarding the potential acquisition of its shareholding in TNK-BP.

In light of these unsolicited approaches and consistent with its commitment to maximizing shareholder value, and its obligations under the Shareholder Agreement, BP has notified Alfa Access Renova of its intention to pursue a potential sale.

There can be no guarantee that any transaction will take place.

A further announcement will be made when and if appropriate.

This follows a press release from TNK-BP three days earlier as follows:

Mikhail Fridman resigns as Chief Executive Officer of TNK-BP

Mikhail Fridman has submitted a letter of resignation to TNK-BP Ltd.'s Board of Directors, notifying his resignation from the position of Chief Executive Officer of the TNK-BP Group.

Mikhail Fridman has also sent TNK-BP shareholders a letter of resignation from the position of Chairman of the Management Board of TNK-BP Management, a Russian subsidiary of TNK-BP Group which manages the Company's assets in Russia and Ukraine, including the publicly traded TNK-BP Holding.

Both resignations take effect in 30 days.

After Mikhail Fridman's resignation, TNK-BP will be managed by a group of executives who hold powers of attorney related to their areas of responsibility.

These two press releases constitute the only known hard facts, but that hasn't prevented a veritable gush of chatter in investor circles as stockholders try to figure out what this could mean for their portfolios.

Here's a Q & A that gives a quick guide to some of the issues.

Q. So what is going on here?

A. BP's troubles in Russia are nothing new.

In 2003-5, BP and the AAR consortium led by three billionaires with Russian connections - Mikhail Fridman, (American) Len Blavatnik, and Viktor Vekselberg - merged their Russian oil corporate assets under the umbrella of TNK-BP.

This joint venture was established on a 50/50 basis, the operation of which required mutual joint decision making. The partners also signed a shareholding agreement on TNK- BP's right of first refusal in relation to potential future oil and gas projects offered to BP or AAR in Russia and Ukraine.

What are these other companies?

A. See the image below, courtesy of Oxford Institute For Energy Studies. This group is known as the AAR consortium.

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Q. And what is TNK-BP, then?

A. TNK-BP is a private, vertically integrated oil company which is one of the world's top ten private oil producers.

It has diversified upstream and downstream portfolios in Russia and Ukraine. Its oil wells are primarily in Siberia and Volga-Urals region. In 2009 the company extracted on average 1.76 million barrels per day of oil equivalent.

Downstream, TNK-BP controls refineries in several Russian provinces and processes 761 million barrels or liquids per day.

The company also runs a retail network of some 1,400 filling stations in Russia and Ukraine working under the BP and TNK brands. The company is a key suppliers to the Moscow retail market and it's a market leader in Ukraine too.

It has proven reserves of 13.1 billion barrels of oil equivalent.

Q. What is TNK-BP worth to BP?

A. A lot. Since 2003 BP has extracted over $16 billion in dividends. The company accounts for nearly 25% of BP's output, one fifth of its reserves, and around one tenth of its profits in recent years.

Q. If it is all so profitable, why the bust up?

A. There has been a lot of bad blood for a while.

On 15 January 2011, Rosneft (OTCPK:RNFTF) and BP announced a deal to develop an oil field on the Russian arctic shelf. As part of the deal Rosneft was to receive 5% of BP's shares (worth approximately $7.8 billion, as of January 2011) and BP would get approximately 9.5% of Rosneft's shares in exchange.

The BP-Rosneft deal was blocked in international courts by AAR - BP's Russian partners in the TNK-BP joint venture - because TNK-BP partners had previously signed a shareholding agreement which stipulated that their Russian joint venture would be the primary corporate vehicle for BP's oil and gas operations in Russia. This was a humiliating setback for BP and its place in the Rosneft Arctic project was taken, instead, by Exxon Corporation (NYSE:XOM).

Q. And now what is the problem?

A. Well, that is the approximately $30 billion question.

The 3 billionaires seem to think that BP is just using TNK-BP as a cash cow, while the other partners want to expand the reach of TNK-BP overseas and make it into a major international player in the oil industry. Some other sources indicate that the reverse is true, that BP wants to invest and expand and the billionaires want to use TNK-BP as a cash cow.

This year the billionaires refused to grant a dividend, stating that in uncertain markets the company needs to stockpile cash for acquisitions or other unspecified purposes.

Q. How can minority shareholders block a dividend?

A. They can't but they are not a minority. They own 50% of the company and BP owns 50%.

Q. Isn't an arrangement like that just asking for trouble?

A. Yes, and they were warned about that by Vladimir Putin before they formed the partnership, but they still went ahead anyway.

Q. So now who wants to buy BP's share of TNK-BP?

No one knows. Is this just a game that BP are playing to put pressure on the billionaires, or is there really an interested party? Apart from the billionaires and Rosneft, there do not seem to be any likely candidates, although Gazprom (OTCQX:GZPFY) has also been mentioned. BP and Rosneft previously offered the AAR consortium $32 billion last year to buy out their 50% stake in TNK-BP, an offer that the billionaires refused.

Q. So what is Mikhail Fridman's resignation as CEO all about?

Good question. Here is an extract from a recent interview with Fridman that was reproduced on the TNK-BP website, translated from Russian.

Interviewer: Is the refusal to pay dividends a way to put pressure on BP, which is now in need of money?

Fridman: Actually, we need money as well. I would say that the general situation in the industry is currently not very favorable for paying large dividends. Oil prices are unstable, and there is a threat of a serious crisis. Besides that, in the absence of a functioning Board of Directors, the company cannot take any decision on borrowing in financial markets.

BP wants ever increasing dividends since they face significant liquidity challenges due to the need to pay compensations for the Gulf of Mexico oil spill, as well as disappointing financial and operational performance. This is why BP insists on dividend payout and is threatening to force the company to do so through international arbitration. At the same time, TNK-BP management believes it would be appropriate to keep the funds that were meant for dividends payout within the company.

Interviewer: To put this money into the investment program or just keep it on deposit?

Fridman: Both options are possible. The main thing is to ensure such a liquidity safety net because we anticipate future deterioration of market conditions.

Overall the impression is that Fridman's resignation is ostensibly a protest against BP's delays in appointing an independent director to the board, but effectively further paralyzes the board, while leaving Fridman free to take part in legal actions against BP regarding the festering Rosneft deal issue.

Elsewhere in the interview he says that the oligarchs' relationship with BP is like marriage where there was love at first, but it has cooled and that it is time for divorce.

Q. Let's cut to the chase. Is this good news or bad news for BP shareholders?

A. So far the market has taken it as a slight positive. BP is thought to have discussed a valuation in the region of $25bn for its stake - but City analysts suggested it is worth anything from $27bn to $35bn.

Whether BP can get full value for its stake depends on who wants to buy and whether there is any competition.

A cash deal would enable BP to wipe out two thirds of its long term debt, and possibly declare a special dividend. On the other hand it may leave the company smaller and thus vulnerable to a takeover bid, which might not be all bad for stockholders, given the currently depressed state of the share price.

There are not many companies that could take over BP, but Exxon Corp. is the world's largest capitalization company and has the heft.

BP Chart
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BP data by YCharts

BP Price / Book Value Chart
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BP Price / Book Value data by YCharts

With BP trading around book value and Exxon Corporation trading a little over double book value, it would appear that a buy out of BP by Exxon Corporation would considerable enhance the value of that book value, or alternatively that BP stock would need to advance to a higher multiple to prevent such a enticing takeover from being plausible.

I'm going to hang on to my BP stock and see what happens next. It may be a rough ride.

Disclosure: I am long BP.