Wednesday, June 23, 2010

New British Petroleum Bond Issue Very Interesting

After being strongly "encouraged" by the Obama Administration to pledge $20 billion into an escrow fund, British Petroleum (BP) is now looking to raise new capital through an upcoming bond issue.  The debt is expected to yield 8-9%.  BP should be happy, Tony Soprano charges 2 points a week.

BP has rapidly descended to the 2nd company "America loves to hate".  And yes, the 1st, "Government Sachs" is participating in the underwriting. 
The obvious question is how well the proposed yield compensates investors for BP's very uncertain credit risk and future liabilities.  The less obvious answer is that it does.

One need not do a comprehensive analysis to determine the attractiveness of these bonds.

Despite a loss of 50% of its market capitalization in 2 short months, BP is still worth nearly $100 billion.  The current value already takes into account expected liabilities from the oil spill.  There are no more than a handful of companies in the world with market capitalizations of that magnitude.

BP's total debt at the end of the 1st quarter of 2010 stood at $32 billion, giving it a very comfortable debt/market cap ratio of about 0.35.  The company's leverage is consistent with an investment grade borrower.

The company earned $16 billion in 2009 with much lower oil prices, and another $6 billion in the 1st quarter from operations.  The recently enacted dividend cut provides another $2 billion in cash flow.  At the current earnings rate, the total debt issue is less than annualized earnings.  BP's price/earnings ratio is now less than 5.

But what about the future unknown liability from shareholder lawsuits?   Tobacco companies have faced them for decades, but none have defaulted.  Remember 20% plus yields on Phillip Morris (MO)?

Drug companies have faced them for years, but none have defaulted.  The auto companies DID default, but not from litigation.  Instead, it was from poor operations and mounting pension and health care liabilities.

In the 1970's, Texaco, then rated Triple A, filed Chapter 11 to restructure onerous pipeline contracts.  No one lost any money.

At 8-9%, BP's bonds would yield more than approximately 40% of the entire junk bond universe, and more than troubled sovereign credits Portugal, Ireland and Spain.  Only Greek debt is higher.

Highly charged incidents like oil spills tend to swing investor sentiment to un-justifiable extremes.  Those who can ignore the market noise from all the hand-wringing stand to make great profits.

Marko's Take

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