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BP’s ‘Strategic Default’ Option

Seeking Alpha

June 17, 2010

Prior to the oil spill, BP stock had a market value of nearly $200 billion. This has been cut by about HALF as a result on the spill.

On the other hand, the culprit, BP America, represents nearly a quarter of BP’s value, or about $50 billion in round figures. This is the amount that BP stands to lose if the oil spill bankrupts BP America. That also appears to be a reasonably good estimate of BP’s potential liability at this time. The $20 billion, to be put into an escrow account, represents a reasonable “down payment.”

The market decline, of nearly $100 billion, assumes that the cost to BP will be much more than $50 billion. That’s a “worst case” scenario, not “most likely” case. More to the point, it is a “worst case” scenario that probably won’t be realized, even if it occurs.

That’s because BP has the option of offering BP America as a “sacrificial lamb,” if the actual cost of the spill is significantly more than $50 billion, just as home owners may choose to offer the bank the house if its value falls below the mortgage. Put another way, BP has put a 20% down payment on a “house” that could cost up to $100 billion (depending on the size of a randomly determined mortgage), but whose “market” value is more like $50 billion.

Even for an oil company, the stock looks cheap at six times earnings. If you assume that one quarter of these will be used to “defease” the company’s liabilities, the ajdusted P/E ratio is more like eight, which is still cheap.

The trial lawyers could try for a judgment against BP greater than $50 billion, upsetting these calculations. They may even get it–in the United States.

But to get “enforcement,” they’d have to go to Britain. Where BP would have the “home court” advantage. And BP isn’t just “any” British company.

It is Britain’s NATIONAL oil company. More important in Britain than GE, Microsoft (MSFT), Apple (AAPL) or IBM, or all of them put together in the United States. Meaning that a fight against BP in Britain would be a fight against the whole British government. That might end up, if necessary, in the WORLD Court.

My first boss told me, “You can’t sue a sovereign without its consent, or at least, without using processes established by that sovereign.” Such a proceeding would make Dickens’ Jardynce vs. Jardynce (divorce trial) look like a moment in time. It could easily outlive the current U.S. Presidential incumbency (assuming eight years).

So I believe that BP stock will eventually rise about 50% from its current market value, and have more than “doubled up” in the past few days, at prices of about $32.50 an ADR. From here, the stock appears to have 50% upside and 10% downside, an attractive 5 to 1 risk-reward ratio. The “workout” time might be 2-3 years, but for potential capital gains ranging from 15% to 22% per annum, that’s worth it.

And that’s not counting the dividend. I’m assuming that when it is restored early next year, the dividend (formerly $3.36 an ADR) will be three quarters of that, or $2.52. That would represent a yield of nearly 8% on the recent price.

Disclosure: Long BP ADRs

About the author: Graham and Dodd Investor
Graham and Dodd Investor picture
As the author of “A Modern Approach To Graham and Dodd Investing,” I use a relatively pure form of the Graham and Dodd methodology reminiscent of the 1930s original. Published in 2004, the book opined: “the world is headed for a situation similar to the last time that the Graham… More

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