Mutual funds look to bank on BP

http://www.marketwatch.com/story/mutual-funds-look-to-bank-on-bp-shares-2010-07-09?pagenumber=1

FundWatch
July 9, 2010,

Mutual funds look to bank on BP
Plunge in troubled oil giant's stock brings out bargain hunters

NEW YORK (MarketWatch) -- Since losing more than 40% of its market value amid the Gulf of Mexico oil spill, BP PLC stock has caught the eyes of certain fund managers who think the battered oil major not only will survive but now offers exceptional value.

According to one bargain buyer, BP's /quotes/comstock/13*!bp/quotes/nls/bp (BP 34.05, +0.31, +0.92%) core operating strengths and the U.S. legal system's slow ruling process will keep the company's head above water.


Tilson Focus Fund /quotes/comstock/10r!tilfx (TILFX 11.26, +0.13, +1.17%) co-manager Glenn Tongue said his midcap value fund picked up BP shares a few weeks after the rig exploded, buying units at $36 a piece. More recently, the fund increased its stake when shares dipped near $27 each.

The portfolio currently has around 4% to 5% of its assets in BP stock.

At its lowest, investors saw 55% of BP's market capitalization evaporate since the Deepwater Horizon accident on April 20, as shareholders sold off on constant news of failures to plug the oil leak, CEO Tony Hayward's controversial actions, storm threats, and mounting claims.

Yet while the public markets reacted to headlines, some managers saw opportunity.

"We love buying when other investors are panicking," said Glenn Tongue and Whitney Tilson, co-mangers of the Tilson Focus Fund, in a note to investors. "We own the stock for two simple reasons -- BP is not going bankrupt [and] the stock is extraordinarily cheap." With BP shares trading around $34 a share, Tongue sees long-term value in the depressed stock, citing an overreaction by the market over spill troubles and ultimate survival of the troubled oil giant.

Looking for returns off clobbered prices, other fund managers have been buying BP stock recently as well.

Hartford Capital made a fresh investment of 4.5 million BP shares in its Appreciation A Fund and added more than 1.1 million shares to its Appreciation HLS IA Fund , according to the firm's May 31 filings.

As of May 31, Fidelity held BP in several of its funds, including an increase of 3.8 million shares in Fidelity Diversified International and 1.7 million shares in Advisor Diversified International . As of April 30, American Beacon also had boosted holdings by 169,500 shares in its Large Cap Value Fund .

Challenges and risks

Tilson and Tongue believe that BP, the world's fourth-most profitable company, will likely cover all clean-up costs and any future fines. Making over $30 billion in operating income each year, the oil giant will be able to "earn its way out of trouble," the fund managers noted, especially if the liabilities are spread over several years.

The fund managers' note suggests that while analysts focus on what the total costs may be, it is also important to know when BP will pay it. For example, Exxon Mobil Corp did not receive a final ruling from the Supreme Court on its Valdez spill until 19 years after the incident.

Looking back on the history of large oil disasters, Tongue said all prior costs were negligible compared to the figures floating around regarding BP's final bill.

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Moreover, many cost estimates overlook the fact that 50% of any uncontained oil is expected to evaporate naturally. "Nature does its part," Tongue said.

Despite this week's 14.6% share-price gain, BP remains undervalued in the public market against industry benchmarks. Shares traded at less than five times BP's forward 2011 earnings versus its competitors' of six to eight times, based on Thomson Financial data.

According to Tongue, the marketplace has discounted about $100 billion from BP shares' market value. He said the fund's analysis recognizes that final liabilities will be "big," but $100 billion is simply "too big."

"Investors overestimate short-term impacts and underestimate long term impacts," said Tongue, also a managing partner at T2 Partners. "Ultimately, we see that [BP's] intrinsic value, the value of its assets, surpass the value the market is applying to it."

Another recent owner of BP also sees the oil producer surviving this crisis. Lord Abbett owned over half a million shares of BP in its Affiliated Fund as of March 31, the most recent filing date. Lord Abbett Senior Economist and Market Strategist Milton Ezrati said he's "skeptical about a BP bankruptcy. BP is very, very important to the British government."

On the sell-side, research analysts have largely maintained buy ratings for the oil major's U.S. and U.K.-listed shares . As of July 1, seven out of 31 analysts held outperform grades for units traded on the New York Stock Exchange, while 27 out of 41 analysts held buy recommendations on London shares.

On Tuesday, Royal Bank of Scotland Group, a British state-owned investment bank, upgraded BP to buy from hold, citing pessimistic view on spill-related costs already discounted into current prices.

Then there are fund managers who have stuck to the other end of the spectrum, staying away from the shares they say are largely news-driven and too difficult to value. Many in this camp say the final amount BP will owe is unquantifiable at this point.

On Monday, BP reported response-related costs have mounted to $3.2 billion.
Fiduciary Management Investments dumped its full position of more than 2.4 million BP shares on June 1, according to a note sent to investors. The firm declined to comment on reasons behind the sale.

Of course, there is a chance the worst-case scenario will strike, where a frontloaded payment of $100 billion might cripple the company to become a takeover target or serve its demise altogether. The possibilities are endless.
But every company is susceptible to risk and the unknown, Tongue explained. While Tilson Funds has gone on record to say the managers do not defend BP's safety record and response efforts, Tongue said their job is to find value.

"Most people don't realize that when they invest, there's uncertainty," Tongue said. "The uncertainty was there the day before the spill. The accident just exposed it."

Cynthia Lin is a MarketWatch reporter based in New York.