Blessed by the Potato

The diet this week was horrible. Ice cream was on sale, which lead directly to ice cream being in the house, which lead to me eating ice cream (for lunch one day, no less), which lead to a 2-pound weight gain this week. Cycling didn’t go so well since the weather’s been so crummy, but I’ve got big plans to go on a personal record-breaking trek tonight to make up for it.

I figure that since BP has made such a wreck of the environment, I don’t need to be quite so good to it, so I bought a few cases of bottled water. Generally I try to avoid bottled water except for when I actually need my water to be portable, and use Brita filters at home (drinking London tap water straight is not usually a very tasty exercise… in the heat of summer it tastes slightly more chlorinated than many municipal pools). However, I’ve been so incredibly lazy that I haven’t wanted to get a glass and pour some water out to drink water; or, when I get to the fridge, I succumb to the tastier options that are in there, like Coke Zero, juice, and milk. Since I don’t mind tepid water, I now keep a case right by my office door to encourage water drinking (don’t even have to go all the way to the fridge!). Hopefully that’ll help the diet too…

Speaking of BP and the environment, I meant to focus more on the horrible nature of the situation in my post, on the Chernobyl-like precedent this tragedy might have in the public mind. How things like the deepwater drilling ban might spur us to say, tax oil a bit more to reflect the costs, or encourage better, faster implementation of crude alternatives in our power and transportation systems.

But I got on the investment thinking train, and that seemed to prove popular, so let me just continue briefly here, hopefully without going into such depth that it deserves its own post. Actually, it deserved it’s own post. This is a quasi-weekly summary/link post-a-ma-gig that I do here, and that was way too detailed.

Links!

The writers of Metatropolis were giving away copies of their books. I got an honourable mention in Karl Shroeder’s contest. That doesn’t get me a free book, but hey, saving on heating bills by using a pain ray on yourself is pretty wild… While it wasn’t a productive week for exercise, it was a productive week for writing, as I now have some drafts ready for the Scalzorc/Wil Wheaton nightmare story contest (and working on my thesis too, honest).

New Scientist has a series of articles on science deniers that look like they might be interesting — too bad they’re behind a paywall (HT: Barry Ritholtz). I’ll see if I can find them through the library later.

Michael James has a post about do-it-yourself investing and how many people want to become DIY-ers to save on fees, but for whatever reason (fear? laziness? momentum? loyalty?) end up sticking with their high-free mutual funds (which hopefully at least come with an advisor). He suggests perhaps taking baby steps, by putting new money in a self-directed account before trying to take the big step of moving out of the old funds. I can relate, as I similarly helped Netbug get set up with a TFSA and TD e-series over a year ago, but AFAIK he never ended up putting any money in that account, choosing instead to “invest with his guy.”

John Hempton of Bronte Capital is always worth reading, especially when he’s tearing apart proposed solutions to the GSE “problem” in the US.

On the topic of BP and the environment: I meant to focus more on the horrible nature of the situation in my last post, on the Chernobyl-like precedent this tragedy might have in the public mind. How things like the deepwater drilling ban might spur us to say, tax oil a bit more to reflect the costs, or encourage better, faster implementation of crude alternatives in our power and transportation systems.

But I got on the investment thinking train, and that seemed to prove popular, so let me just continue briefly here.

First up, I’ve been trying to pay more attention to the story in the media lately. I was a little surprised to see a guest on BNN the day after I put my last post up saying almost word-for-word what I said about this disaster not killing BP outright, so at some point there must be value in the stock. He followed up by advising people to not catch the falling knife though, which is advice I have a particularly tough time following, so it’s good to hear again.

BP has now successfully cut off the top of the riser pipe down there, making for a cleaner hole. That makes it possible for them to siphon some of the oil off of the gusher and up to a surface ship. It also unfortunately allowed more oil in total to be released, which will be really bad if say a hurricane starts to form and the surface ships have to skedaddle. I thought that net-net, it was a positive move, but that may be a close thing, depending on how close to the upper end of the range we were at for the size of the gusher: if they’re collecting ~15k barrels/day, and the cut in the pipe allowed 20% more oil to escape, then that’s a losing move if the size of the leak was over 75 k barrels/day. I actually expected BP’s stock to jump on that news, but it had another horrible day today (down almost 16%). It’s now under $30, which has me making “Om Nom Nom” noises.

One thing their collection operation proves though is that the early estimates of oil flow were way, way too low. The most-reported estimates of the size of the spill are still climbing day by day in the media, but now seem to be plateauing in the lower range of what the image analysis guys were saying (i.e., in the neighbourhood of 50k barrels/day). Not all of that is making it to the surface, and there’s no way to tell yet whether or not that’s a good thing. Obviously it’s harder to skim/clean oil that for whatever reason is remaining dispersed beneath the surface, but maybe we’ll get lucky and it won’t need to be cleaned. OTOH, it may poison marine life for decades to come. No way to say just yet, I think.

Alongside the climbing volume estimates comes the climbing cost estimates, which are now closing in on my back-of-the-envelope $50B figure. At that point, I still have to think that BP is value-priced now at < $30. Some articles today raised the spectre of bankruptcy for BP, which I think is highly unlikely given the facts on the ground right now — as I said before, BP is a very profitable company, and can afford to make good on even large payments if given time (and litigation will likely give them that time). Even a $100B final price tag wouldn’t kill them if they had 5-10 years to pay out, though it would mean that the stock would have more shit left in it to get kicked out. Despite the fact that I’ve been pretty pessimistic on the scale and cost of this disaster so far, I think $100B is probably the upper-end of the range.

That is, assuming that the relief wells being drilled right now are able to stop the leak before the end of August. A 3rd-party drilling expert was interviewed on BNN the other day, and he gave me hope that this would work. Specifically he said that these kill wells have a greater than 90% chance of success, and are very good at being able to find the borehole underground. With two drills going, there’s a very good chance this will stop before the fall.

In the scenario that the kill wells fail (or to compound a tragedy, one of them blows out) then there is unfortunately no salvation for BP. If this thing leaks for the better part of a year like Ixtoc, then the Clean Water Act penalties and other settlement costs could conceivably bankrupt them. I can’t say that it won’t happen for sure, but I discount it as a very remote possibility.

On the matter of the dividend there has been a good deal of commentary. It’s a tough call. On the one hand, they do have enough cash on hand and cashflow being generated to pay for the ongoing costs of the cleanup at the moment, so a dividend cut isn’t strictly necessary. Plus, it’s a “widows and orphan” stock, especially in Britain, so there’s some pressure to continue to pay a dividend (even if a reduced one). On the other, there are the optics, which can cut both ways. They may seem callous to the situation by paying out cash to shareholders in the midst of the crisis (and powerful politicians are calling for them to cut it). To a lawyer in front of a jury though, a cut and the buildup of a reserve fund may just be a target — however much they build up, a court may reason that they should award more in damages to make the award truly punitive. Giving the cash to their limited-liability shareholders may help keep the court awards/settlements down. The dividend is pretty rich, but I’m not sure that eliminating it for a few years should really affect the investment thesis all that much — the uncertainty in the cleanup costs is much higher than that, so I don’t get the news reports saying that the stock declined on rumours of a cut. I think that they can keep it up, but will probably cut (not necessarily to zero though — probably down to 25-50% of what it was), however either way I don’t think it’s a significant enough factor to affect my value price.

So after looking at it a little closer, my back-of-the-envelope calculation doesn’t seem all that far off to me: BP is likely getting into the buy range now (under $30 for the NYSE ADR), and it might just be a matter of waiting for it to stop being sold in a panic to get in as a long-term value/recovery play. That said, it’s definitely getting detached from the fundamental issues here and trading on emotion in my opinion. It could go nowhere until the relief well connects and kills the leak; it might stay low until a decade from now when the settlement payouts stop and people see the EPS clearly again. It might spring back 15% tomorrow on no news. Some big-name analyst might pan it and it could go no-bid until the vultures start picking it up for pennies. Just no way to say in the short term. That said, the bonds may also be well worth looking at: I haven’t bothered to log into the fixed income side of my broker’s website, but the paper today said that their debt was now yielding 8% — and that was just a 3-year bond! — which plays even better into the “they won’t go bankrupt” thesis (especially if you conclude with “at least not in the next 3 years”).

Another side to the catastrophe that I haven’t seen mentioned yet is the fact that a large portion of the release appears to be methane. As we know from the snickering over cow farts, methane is a very potent greenhouse gas, and here we have a rather substantial release of the stuff going on. I have to wonder if it’s going to be enough to affect the climate records for the next 10-20 years, though I suppose that’s a problem to worry about after the spill is stopped.

One final note on government malfeasance. Some have speculated that the US will simply confiscate BP (or it’s american assets), or create legislation to penalize them post hoc. That is expressly forbidden in the US constitution. However, the US government’s actions during the financial crisis (seizing banks that were not necessarily demonstrably insolvent; arbitrarily making bondholders whole and wiping out common and preferred shareholders without the benefit of a release of their calculation arriving at such a split or orderly liquidation; their continued efforts to keep the GSE’s down with ridiculous interest payments on money that they are forcing them to borrow, which the GSE’s don’t really need — what use capital requirements when possessed and guaranteed by the government?) do not inspire continued faith in the concept of due process.

PS: note that when I say “today”, I mean June 9th (I composed this the evening of June 9th, but held off until June 10th to hit publish).

I was out helping a friend car shop today when I ran into a fairly sleazy dealer tactic. The guy was actually a pretty good salesman: enthusiastic, knew the car, personable… but then he started hammering out numbers (using the “adjust to a certain monthly budget” method) too fast to follow. He was trying to beat a quote she got from Mazda, which has 0% financing right now, and he said that Kia didn’t (though when we checked the website afterwards, they did). He was going to discount the car to make up for the financing, and was hammering away on the calculator. He turned the calculator around, and said he could do $162. We were like wow, that’s less than half of Mazda’s quote. “Oh, no, that’s bi-weekly, so multiply by 2 to get $324 per month. Pretty good, right?”

Pretty sleazy, actually. There are 26 bi-weekly periods in a year, but only 24 twice-a-month periods. So to get a monthly payment from a bi-weekly one, you have to multiply by 26 and divide by 12, which is 2.167, not just 2X. So he was actually presenting a $351/mo payment, which was more than the Mazda.

I love free stuff (especially food — the grad student cliche is true). It’s like cheap, only better.

However, I turn down a lot of free stuff that I know isn’t actually free: it comes with strings that you have to untangle later, especially free crap I don’t really want. The telemarketers sometimes get confused at this (or are trained to act confused when people reject their offer of free crap), why would I turn down free crap when I can call back within 30 days and wait on hold for an hour and go through 6 automated menus to cancel?

Ellen Roseman this week covers the case of Seema, another newb who fell prey to Extreme Fitness. Their business model is built on the free trial followed by lock-in concept, yet Seema jumped for it, signing up for something she had “NO intention whatsoever” of actually signing onto long term just to take advantage of a free trial. Due to a mix-up of cancellation times, she ended up calling back 4 days too late and they tried to lock her into paying for a full membership. Fortunately, Ellen Roseman rode in to the rescue and helped get her out of the contract.

The lesson? Don’t sign up for crap you have no intention of using, even if it’s (temporarily) free. That goes for gym memberships, magazine subscriptions, Rogers TV upgrades, Bell phone features, credit card insurance, music subscription services, credit reporting services, World of Warcraft accounts… need I go on?

In fact, I think at least a quarter of the consumer activism Ellen works towards could be eliminated if people just followed this one simple rule. TANSTAAFL.

You’d have to have been in a hole the last month to have not heard about the disaster in the Gulf of Mexico leading to huge amounts of oil streaming out of a well after an accident at the rig. The oil under the ocean floor is under a great deal of pressure, so it’s pouring out through the hole, and has been for a month now. And every day, more comes streaming out. The slick on the surface is huge, affecting a large number of fishery operations, and coming ashore now.

This is a massive disaster, and it’s not over yet. It could be another month or two before the gusher is finally brought under control, and then a long time after that mopping up the coastlines.

For some perspective I did a quick bit of reading on the Exxon Valdez spill. The oil was thicker on the coast there, in large part because the tanker grounded fairly close to land (esp. relative to the BP drill site).

As this plays out there may be more realization in the public mind of what the externalities of an oil-based economy are, and we may finally get more of a drive towards alternative energy, public transit, hybrids, etc. Plus of course, stricter regulations on environmental protection for drillers (though like with financial reform, closing the barn doors after the horse has run out).

From an investing point of view, people are looking at the massive decreases in BP’s stock over the last month — 30% over the last month, 15% today alone! — and are wondering whether this is now becoming a value play. I doubt very much that this disaster will lead to BP going bankrupt and the common shares becoming worthless. Thus at some point, there must be value in the stock. However, determining what that point would be is very difficult at this point since there is so very much uncertainty at the moment. To be sure, uncertainty and volatility can present opportunities, and there’s a good discussion about that possibility at CMF right now.

So, a quick back-of-the-envelope calculation: the ultimate costs to BP are probably the largest unknown factor, but also the most important here at trying to guess at the bottom. The Exxon Valdez spill ended up costing Exxon in the neighbourhood of $5B. This is likely going to be about 10X worse (BP has reportedly already spent $1B in the first month on cleanup and well capping attempts — and the litigation hasn’t even started). So I’d start with a guess of about $50B to clean things up. That figure makes me more pessimistic than most of the reporters and analysts I’ve seen in the news, but there’s so much uncertainty here that I think it could end up being more. At the very least, I’d be looking for a margin of safety on top of that before I start bottom-fishing. As big as that number is though, it’s not a killer for BP: it’s a huge company with profitable oil operations all over the world, and it can probably pay out the costs of the cleanup out of operating profits over the next few years (as they’re required for cleanups, or as litigations complete).

Let’s assume that we’re willing to pay a stock price of the sum of the earnings for the next 10 years (i.e. a P/E of 10). Their earnings for 2009 were about $17B, so 10X that gives us a 10-year sum of $170B, or a stock price of about $54, which is where they were trading before the disaster. If we now figure that $50B comes off that 10-year sum, we’re left with earnings of $120B, which would be a stock price (US ADR) of about $38 (which as of today it’s below). On top of that, we want a margin-of-safety of at least 20% (though I think given the uncertainty, a higher margin of safety would not be out of the question). That brings me to a price of about $30-31 before it starts to look interesting to me. I haven’t done a whole lot of research since I’m busy with my real life, but if BP does start getting down into that range, I might give up a Saturday afternoon to sit on the porch and read up.

All that said, the bloody thing dropped 15% in a day. I’m not going to touch it for at least a few more days. Plus there’s the ethical investing issue: even if it is bargain-priced, do I want to own a fractional share of a company that was responsible for such a massive environmental disaster?