BP should be back on bid alert

April 8, 2011

By Fiona Maharg Bravo and Christopher Swann
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

MADRID/NEW YORK — BP has the hallmarks of a bid target — a discount share price, a strategic setback and weakened management. Almost a year since the Gulf of Mexico spill hobbled the company on its Western front, the UK oil major has got bogged down in Russia, leaving it exposed again.

Adjusting for the gain in global stock markets, BP’s $146 billion market value is $75 billion below where it was before the Gulf spill. Even if BP was found to be grossly negligent, the post-tax bill would add up to just under $50 billion. The problems in Russia, which account for about 10 percent of BP’s profits, justify some additional discount. An arbitration court ruled that BP’s proposed drilling alliance with oil giant Rosneft breached the terms of its existing Russian joint venture with TNK-BP. Any resolution of the spat will be complex and potentially costly — whether it involves buying off its partners in cash or perhaps even BP equity.

That BP could have got itself into a row with TNK-BP — the pair fell out in 2008 — is bad enough. But it’s especially serious given the chief executive, Bob Dudley, used to lead the venture. Worse, BP is talking about swapping 5 percent of its equity for a stake in Rosneft even if TNK-BP succeeds in blocking the drilling alliance outright. There is little justification for issuing stock to a Russian state-backed group with no tangible benefit.

Ultra-cautious Shell would not make a hostile offer, and BP’s management is focused on pursuing its “shrink to grow” strategy. But Exxon must be tempted to exploit the situation. The cost savings in its 1998 Mobil deal were about 10 percent of combined operating expenses. On that basis, the savings from an Exxon-BP combination would be $12 billion a year. The industry has cut some fat in the last decade, so perhaps $10 billion is more realistic. This would be worth around $70 billion. That’s enough to fund a $45 billion, or 30 percent, premium for BP shareholders, while leaving headroom for potential costly resolutions in the Gulf of Mexico and Russia.

Yet a deal still looks complicated. Antitrust regulators would probably force Exxon and BP to sell U.S. refining and marketing activities, and that’s not exactly a seller’s market. The Macondo fiasco is still a big headache, and there is not yet a solution in Russia. And then there are the political challenges in an assault on Britain’s national oil champion. If Exxon made a move, Shell might be drawn in as a white knight.

Few expect a deal to happen in the short term. But the longer BP’s shares languish, the more the financial logic of a deal could tempt Exxon to overlook the snags. For BP’s board, the biggest test may be yet to come.

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