Marriage and Divorce Corporate Style (Part 1)

And BP PLC

The Betrothal of Reymont and Melusina, 15th century, courtesy Wikipedia

International corporate marriages can flourish and last forever - provided, it seems, that they are between the English and the Dutch. Royal Dutch Shell, Unilever, Reckitt Benckiser and Reed Elsevier are but the more notably successful Anglo-Dutch alliances. The most disastrous marriage for a British company was Dunlop's flirtation with Pirelli. They married in 1971 and divorced in 1981, leaving Dunlop in such a precarious situation that it fell into the arms of the asset stripper, BTR, 4 years later.

IAG (International Airlines Group), formed by the British and Spanish flag carriers in 2011, is the latest betrothal. BA was burdened by an enormous pension fund deficit, Iberia by its overpaid and overstaffed structure and both were fearful of low cost competition in their European heartland, where they were losing market share. And each was smaller than their major European competitors, Lufthansa and Air France-KLM. The shotgun nature of the wedding does not bode well.

True corporate marriages, where each party agree a split of shares and functions, are rare. Joint ventures that outgrow both parents, leaving a de facto marriage where none was intended, are rare too. So it is unusual for three large companies quoted on the London Stock Exchange to be simultaneously at odds with their marriage partners. But such is the case with BP, Bumi and Vodafone.

BP

In 2003, BP set up a joint venture, 50-50, with three Russian companies (forming AAR) owned by 4 billionaire oligarchs  to create TNK-BP. BP agreed to help the Russians create an oil major. Both sides pooled their oil and gas businesses in Russia and the Ukraine. The marriage seemed to be going swimmingly. BP received $19 billion in dividends from 2003 to 2011, a wonderful return on the $8 billion it had valued as its contribution to the joint venture. 

By 2011, TNK-BP accounted for 27% of BP's reserves, 29% of its production and 25%, or $4.2 billion, of its net profit attributable to BP shareholders. Tensions between the partners began early in the marriage and finally came to a head when AAR scuppered (via the English courts) a deal between BP and Rosneft, a big Russian oil company, to explore the Arctic without TNK-BP. BP needed cash to pay the costs arising from the Deepwater Horizon disaster, and it divorced AAR, selling its 50% share in TNK-BP to Rosneft. BP received $11.7 billion in cash and an 18.5% holding in Rosneft that BP values at $21 billion. The operation was completed in March 2013. 

The divorce left BP's Russian strategy in tatters. ExxonMobil stepped in to get the Kara Sea (Arctic) and Baltic Sea exploration rights with Rosneft. And BP is left with a minority stake of 19.75% in a company which is 69.5% owned by the Russian government.  The loss of TNK-BP may, in the long run, prove to be more costly to BP than the Deepwater Horizon disaster. 

How did such a promising and successful venture come to such a sudden end? BP realised that, given the political situation in Russia, success in developing Russian oil and gas depended on finding Russian partners. The Russian partners, AAR, needed the technical expertise, management and access to international finance of BP to achieve their goal of becoming an oil major. But AAR expected more than BP was willing to provide. While AAR wanted to create a worldwide oil company, BP was interested in keeping TNK-BP within the confines of the old Soviet Union. Further, in 2007, BP began negotiations with Gazprom, a large Russian gas company, to take over AAR's stake in TNK-BP. BP saw Gazprom as a stronger partner than AAR. As AAR did not want to sell, this did not prosper, but it did nothing for matrimonial harmony. 

AAR exerted pressure on BP by way of its excellent relations with the Russian government. BP staff working for TNK-BP suddenly could not get visas. Police raided TNK-BP offices run by BP staff. Mr Robert Dudley, the American CEO of TNK-BP, was placed under such pressure that, in 2008, he fled Russia in fear of his life. He was replaced first by one of the AAR consortium and then by Maxim Barsky, a young and relatively inexperienced oilman, who was the candidate chosen by AAR. BP had lost control of TNK-BP. 

In 2010, BP, under its new CEO, the same Mr Dudley, decided to circumvent its partner AAR and explore the Arctic waters for oil with Rosneft, a Russian competitor to TNK-BP. Rosfneft is a favourite with the Kremlin leadership, and a most attractive partner. But this contravened the shareholder agreement with AAR, and the Rosneft deal was declared unlawful by an English court. BP had cheated on AAR, was found out and divorced AAR to marry Rosneft. 

The value of a company includes the quality of its management. Company reports and press releases are often illuminating in this respect. If the company is large or newsworthy, articles on or by managers are to be found in the press and online. BP had a poor safety record long before Deepwater Horizon. Poor management in one area often spills over into poor management in another. Consider the managerial blundering of TNK-BP by BP: 

1. At the outset, BP had 5 directors on the board of TNK-BP. AAR had 4. The CEO, it was agreed, would be appointed by BP. At the end, each partner had 5 board directors with 3 independents. 2 of the independents were employed by Russian concerns. BP lost control of TNK-BP to AAR, who installed its candidate as CEO. 

2. If a partnership is to succeed, you don't go looking for other people to replace your partner. Which is what BP did with Gazprom in 2007. It doesn't take much imagination to understand how this flirtation offended AAR. 

3. BP negotiated the joint exploration of the Arctic sea with Rosneft in 2010, when its shareholder agreement with AAR did not permit such alliances outside TNK-BP. Not only did BP lose the contract to ExxonMobil, but it also declared war on its partners in TKN-BP. A war it could not possibly win. 

4. With the sale of TNK-BP, BP lost 27% of its reserves, 29% of its production and 25% of its net profit attributable to BP shareholders.  

This is not the end of the story for the minority shareholders who invested in the publicly quoted TNK-BP on the Russian stock market. After buying out the majority shareholders, Rosneft variously announced that TNK-BP minority shareholders were the responsibility of BP, that TNK-BP would take out a large loan, presumably to finance Rosneft, and finally that TNK-BP would pay a dividend, but much less than in prior years. TNK-BP shares have slumped by 55% from their 2012 peak:

 

Graph courtesy of the Financial Times, price in Roubles, click to enlarge. 

BP is a minority shareholder in Rosneft. Will BP get better treatment?  

Note: I will be returning to Bumi and Vodafone next week.

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What is BP PLC worth?

Deepwater Horizon drilling platform courtesy Wikipedia 

3 years on from the 2010 Deepwater Horizon disaster, BP is a shrunken yet financially strong oil major. The company has raised $50 billion, including the cash proceeds of its sale in TNK-BP, towards its $41 billion provision for compensation, damages and fines arising from the largest oil spill in US history. It is shrunken because: 

1. Oil and gas production is down 42% from 4 million barrels of oil equivalent (BOE) in 2009 to 2.3 million in 2012, once BP's share in TNK-BP is excluded. 

2. Proven reserves of oil and gas are down 44% from 18.3 billion BOE in 2009 to 10.3 billion today. 

3. BP's market cap has fallen 27% from 122 billion pounds before the oil spill to 90 billion now. 

4. Earnings per share has declined 53% from 88 cents in 2009 to an adjusted 41 cents in 2012 (see text below). 

But BP is financially strong. At March 2013 BP had a cash reserve of almost $30 billion and a net debt to equity ratio of only 13%. Moody gives BP an A2 rating even after discounting an increase to $60 billion for the total cost of the Deepwater Horizon disaster.  

Compared to its great rival, Shell, BP shares have underperformed by 35%:

Graph courtesy of Yahoo, click to enlarge. 

Is BP worth buying at 473p? 

If we can take as a base of BP's ongoing business its 2012 results, adjusted for the sale of TNK-BP and 2 other items, then its base earnings per share is 41 cents. This adjusts 2012 profits of $11.6 billion for: the $3.7 billion net contribution of TNK-BP to profit after tax; the $6.7 billion pre-tax gain on the sale of assets to meet its Deepwater Horizon liabilities; and adds back the $5 billion pre-tax provision for Deepwater Horizon liabilities. On this basis, BP shares are currently on a PE ratio of 18 and they yield 4.4%. Compared to Royal Dutch Shell shares, which are on a PE of 8 and yield 4.8%, this is expensive. 

There are further considerations: 

1. If the final cost of the Deepwater Horizon disaster is $60 billion, as Moodys expects, then BP will no longer be in the very strong financial position it is in at the moment. But the company has the resources to make the additional $19 billion payout, which it has not provided for in its accounts, without having to sell off any more of its assets. 

2. No value has been placed on BP's almost 20% share in Rosneft. It must be worth something, but given the experience of foreign companies operating in Russia, it would be foolish to assign a value to a minority holding in a company owned by the Russian state. 

3.  BP has invested $7.6 billion in wind farms and biofuels with no return to date. Indeed the 2012 accounts include an impairment charge of $318-million for this business and the company does not give any figures for its operating results on the grounds that they are not material. It would seem we are observing another case of BP mismanagement.  

4. BP and Shell face a growing liability for their defined benefit pension plans. In 2012 BP booked an additional $1.5 billion charge directly to its balance sheet for the liability. This did not pass through the profit and loss account. Pension liabilities will continue to grow. 

5. Taking the rough measure of their respective oil reserves and production, BP is undervalued compared to Shell: Royal Dutch Shell's market capitalization is 53% more than BP's, but its oil and gas production is 43% higher and its oil and gas reserves are but 32% higher than BP's. 

While it is impossible to give a valuation for BP, given the uncertainty still hanging over its business, its shares look expensive when compared to Shell. And Shell has the better management. See http://thejoyfulinvestor.blogspot.co.uk/2013_02_03_archive.html