This April 21, 2010 file photo shows the Deepwater Horizon oil rig burning after an explosion in the Gulf of Mexico, off the southeast tip of Louisiana. Decisions intended to save time and money created an unreasonable amount of risk that triggered the largest offshore oil spill in U.S. history, a disaster that could happen again without significant reforms by industry and government, the presidential panel investigating the BP blowout concluded Wednesday, Jan. 5, 2011.Gerald Herbert/AP
We'll call it disaster investing: profiting from catastrophes that befall otherwise solid companies. The disasters can vary, but the strategy for handling any of them is to trust that cooler heads will prevail.
The most spectacular recent example is the BP PLC oil spill. Within weeks of the explosion and fire at a well in the Gulf of Mexico last April, BP's share price had plunged by half. Investors who remained calm and bought near the bottom are now up more than 100% on an annualized basis.
What did those buyers see that sellers didn't? Nothing. It was how they interpreted what was happening that separated them from the stampeding herd.
Among the buyers were Ming Lam and Kevin Kuebler at Silver Heights Capital Management in Toronto, a value shop with a good track record. The money managers began buying BP shares at just under $32 (all currency in U.S. dollars) last June. The price has climbed to $48, and Lam figures they're still worth a lot more.
That looks like an easy call now, but it wasn't last year. Even some analysts said that BP was finished. The media was awash in stories about huge black tides washing up on U.S. shores and tens of billions in damages to the economy. The Obama administration was vowing to find out "whose ass to kick."
But is a panicky sell-off enough reason to buy? Lam and Kuebler started to see real opportunity in mid-June, after BP suspended its dividend-mainly to appease politicians. First, the duo assessed the likely cost of the spill to the company. The media breathlessly predicted $30 billion to $50 billion. Lam and Kuebler figured it would be lower. Yet even if the total was $100 billion, they concluded that BP's annual cash flow of about $30 billion could easily cover the bill-so long as the company didn't have to pay a bill that large all at once.
The duo was also wary of media stories about environmental cataclysm. "The Gulf sits on top of a huge oil reservoir," Lam says. "Oil is constantly seeping into it. There are organisms that eat oil." As it turns out, huge black tides never did swamp Gulf shores, and much of the spilled oil is already gone-devoured by microbes or dispersed. So Lam and Kuebler concluded that BP wasn't going to go bankrupt.
The next step was valuation. BP's financial track record is stellar. Over the past 13 years, the company's annual return on equity has averaged about 20%.
Another irresistible metric was the value of the vast, high-quality oil reserves on BP's books. When the company's shares dropped to $29, Lam and Kuebler calculated that you'd be getting its reserves for $8 a barrel, even after factoring in clean-up costs in the Gulf. On average, oil companies now spend more than $20 a barrel to find and develop new reserves. BP's share price was starting to look absurdly cheap.
But there was still that political X factor to assess. Lam and Kuebler reasoned that crippling damages were unlikely. Bankrupting BP would scare many multinationals away from the United States. Better for Washington to collect, say, penalties of $5 billion a year for 10 years than to attempt a messy crackdown that might fail. BP was worth more alive than dead.
In the end, remaining dispassionate proved to be profitable for Lam and Kuebler. It wasn't Obama who kicked butt; it was investors who ignored the noise and made a smart bet.
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DO SHARE PRICES ALWAYS REBOUND AFTER A DISASTER?
MAPLE LEAF FOODS: Listeria outbreak at a Toronto meat processing plant, August, 2008 Gain or loss relative to pre-disaster price: One year later: -16% Now: +10%
"Yes, this is a tragic situation, but we are a very strong organization. We have a strong balance sheet and a great relationship with all of our stakeholders." -CEO Michael McCain, November, 2008
MENU FOODS: Recall of contaminated pet food, March, 2007 Gain or loss relative to pre-disaster price One year later: -90% In November, 2010, when Simmons Pet Food bought Menu: -35%
"Menu is a great company with an excellent management team." -Simmons Foods chairman Mark Simmons
TALISMAN ENERGY: sued by the Presbyterian Church of Sudan for alleged human rights violations Gain or loss relative to pre-disaster price: One year later: -2% Five years later: +188%
"It is time for Talisman to turn the page and focus on our other excellent assets." -CEO Jim Buckee on Talisman's sale of its Sudanese assets, November, 2002
PLACER DOME: Marcopper Mine waste spill in the Philippines, March, 1996 Gain or loss relative to pre-disaster price: One year later: -32% Five years later: -64%
"[We]asserted our inherent principles and strengths in an emergency." -CEO J.M. Wilson, 1996 annual report