Street Capitalist: Event Driven Value Investments

I just caught a CNBC’s Situation Room where they had David Barse of Third Avenue on BP (NYSE:BP). Third Avenue is a legendary value investment fund that used to be run by Martin Whitman. They take a really disciplined, Benjamin Graham-like approach to value investing and often will go into distressed debt situations and workouts.

The folks over at CNBC asked him some questions about the current BP situation and I thought it would be worth sharing. This is not a transcript but just notes that I took from a recording.

I was actually looking forward to this because I believe it is the first time I’ve heard of a value investor talking about BP.

Now that there is a $20B escrow fund established by BP, is it time to look for value?

Barse: There is another level of certainty that value investors, or contrarians need.
Still too much uncertainty, contingent liabilities that are unknown, timeframes of repayment that are unknown. That can affect your return on investment. Not really safe and cheap, which is what Third Avenue does.

Some value investors have reported that they are taking a dip into BP. Do you think they are just taking a speculative trade here?

Barse: Probably. Because there is still great uncertainty. It is a tough call.

Any analogous situation here from your long investment career?

Barse: Let’s look at Texaco. A company that was solvent that used the bankruptcy process to stem an uncertain liability, stabilize the market, and reorganize the company in a rational way. That might be an avenue for BP.

When you look at the situation, you don’t know the overall. With Texaco you had the whole Pennzoil case. Do you think there would be any benefit for equity investors for filing?

Barse: Our laws are written to protect the debtor. In this case, they are the debtor. It is certainly something that behooves them to look at and analyze. Is it proper for the President to tell them how much to put in an escrow account? Right now it is a company owned by the shareholders.

How will they fund the $20B? Do you think they will do a debt offering?

Barse: Okay so, this is a company that has access to capital markets, but certainly the cost for that access is going to be higher than it was prior to the crisis happening. That is a factor they will work into that decision. This would be a debt offering that would get an oversubscription because it is a great company. It is a company that is certainly a survivor. Long term, this will cost less than the market cap.

So you think it will cost less than $100B?

Barse: Based on what we know, it seems like it will be less than that. But it is an uncertainty and that is why we are not investing in the equity.

Could some bond managers that are unhindered by requirements dealing with ratings look at BP?

Barse: In the market environment of last year when credit was wider in terms of spreads, we launched a focused credit fund to invest in situations like this. We call these special situations and certainly the yield for a BP… We would take a much closer look at a debt offering.

Barse ended with a recommendation that people should look at Hong Kong property stocks.

As you can see, one of the big topics of the discussion was on the newly announced $20 billion dollar escrow account that BP agreed to establish. The New York Times has details on it:

The White House and BP tentatively agreed on Wednesday that the oil giant would create a $20 billion fund to pay claims for the worst oil spill in American history. The fund will be independently run by Kenneth Feinberg, the mediator who oversaw the 9/11 victims compensation fund, according to two people familiar with the deliberations.

The agreement was not final and was still being negotiated when President Obama and his top advisers met Wednesday morning with BP’s top executives and lawyers. The preliminary terms would give BP several years to deposit the full amount into the fund so it could better manage cash flow, maintain its financial viability and not scare off investors.

The talks have been complicated by the fact that BP’s ultimate liabilities for the cleanup and lost business are unknowable since the two-month-old leak of its well in the Gulf of Mexico could be spewing oil for months more. To date, BP has spent more than $1 billion on containment, cleanup and claims from the Coast Guard, fishermen, oil workers and other businesses from Louisiana to Florida.

BP Agrees to Set Aside About $20 Billion for Spill Claims (NYTimes)

Overall, I think his approach is a good example of real value investing. A lot of pretenders are out there, looking at the stock, and they do these really simple (or poor) calculations. They will look at the operating cash flows and not the capital expenditures. Or they will assume a payout of $X billion dollars over 20 years when maybe the requirement will be payments in 5 years. Maybe as a result of this spill, BP will have a much more difficult time getting contracts to do deepwater exploration and as a result, their franchise will be permanently impacted. With all the uncertainties it is a really difficult call when you are trying to determine BP’s intrinsic value.

I think that Barse’s idea of looking at the debt is a good one. The recent downgrades by Fitch and others will preclude certain bond managers from buying their debt. Plus there will be a social stigma attached that might lead environmentalist groups to urge pension funds and endowments from BP related investments. These situations could make the debt offer an attractive yield to agile, unhindered investors.

Edit: Whitney Tilson is another value investor who has actually been bullish on BP for over a week. Still, I think Barse’s insights — especially from his bankruptcy background add a lot of value since it is a scenario that has been talked about.