Bondholder Beware

BP may not be going bankrupt, but someone's going to pay

 

How Bad Could it Really Be?

 

The simple answer is that nobody knows. Of course, there's no shortage of people guessing and some of it is pretty entertaining (thank you, Matt Simmons, via Tyler Durden). What I'd like to address is the real potential liability associated with Tony Hayward's "all legitimate claims" promise.  

 

The largest apparent black hole into which BP and others are likely to throw money could be characterized as "economic damages to those who depend on the Gulf of Mexico for their livelihood". These include reasonable claims such as fishermen who can't fish because of the oil. The difficulty comes in deciding how far to take it. On the local NBC affiliate here in Houston we were treated to a Bart's People Segment human interest story about a local eatery whose business has been decimated but the "oil spill." It's not clear to me how a soul food restaurant 50 miles from the Gulf Coast in the middle of Houston would so affected by oil that hasn't even made it to Texas. Further, I have it on good authority that the food at this recently opened national treasure sucks is subpar. Nevertheless, there stood Congresswoman Jackson-Lee demanding restitution for this unfortunate business owner. This bit of anecdotal evidence, combined with the daily barrage of stories about people similarly situated along the Gulf Coast convinces me that there are going to be many, many people with their hands out. One might even call them a "Class" who would want to take some sort of "Action".

 

So how much could they "legitimately" ask for? With a little top down analysis, we can made a reasonable back-of-the-envelope guess. The combined Gross State Product (GSP), according to BEA, for Louisiana, Mississippi, Alabama and Florida comes to approximately $1.16 trillion. (These are round numbers - precision in this kind of analysis gives the illusion of greater accuracy than can be hoped for). Of this, Florida represents $735 billion, or about 63% of the total. Tourism is the largest sector of the state's economy. Given the massive weight of Florida in our calculations and the likelihood that everyone with even a passing relationship with the industry will make a claim, it seems reasonable to me that BP could be facing claims in the range of 10-20%  of GSP for the effected states. That translates to approximately $110-$220 billion. That's a lot of cash and it only covers this season. And not a dime of that goes to cleanup.

 

Ok, But BP is a HUGE Company

 

Yes, they are. But they can't take a hit like that. Operating Cash Flows for the three years ended 12/31/2009 totaled $90.5 billion. So we're looking at four years of cash flow to get to the low end of our estimated damages. They won't be able to borrow the money. Even a dimwit European Banker knows this is the exact situation that "Material Adverse Change" clauses are written for. Could they liquidate? Net Tangible Assets as of 12/31/2009 were only $81.4 billion. (Remember, oil and gas assets are marked to market so that's actually a pretty good estimate of value). Again, no dice.

 

Three Impossible Things

 

So what are we left with? We have a huge and very profitable company with a massive unknown liability. The only why it could ever be satisfied is for the company to continue to operate but with a new capital structure. Bankruptcy looks inevitable.

 

But wait, there's a serious problem with the equity holders. Apparently a huge number of British pensioners depend on BP's dividend. (Anyone with a good estimate, please let me know.) Worse yet, Great Britain is a key US ally in our wars in the Middle East. It's hard to imagine the US (or some two-bit tort lawyer) putting BP into bankruptcy. Nobody's going to put British grandmas on the street to pay a class action judgment in the US.

 

We're left with three impossible things: the company can't pay off this massive liability, can't cut the dividend and can't file a traditional bankruptcy.

 

A Rock and a Hard Place

 

When Rocks and Hard Places come together, somebody gets crushed. In this case, the Rock appears to be a massive unsecured liability that the US government is going to make sure gets paid, and the Hard Place is the equity holders that the British government won't allow to get wiped out. So who does that leave with claims on BP's cash flow that could get fucked restructured? Think GM. Bondholders beware.