T2 hedge fund
Whitney Tilson

There is an ongoing debate whether British Petroleum (NYSE:BP) is a value stock or a value trap. I laid out the case in a previous article that BP presented an exciting opportunity. The article stated that there is a 200% upside and a 100% downside. Assuming there is 50/50 chance of BP declaring bankruptcy (I believe the chances are lower), the risk reward/ratio is very high.

In the article, I also stated Whitney Tilson was very bullish on BP. Below is a video from the previous article of Tilson stating the bullish case of BP.

Tilson was featured yesterday in Baron’s, and expanded on why he is long BP.

AS VALUE INVESTORS, we’ve owned a lot of unpopular stocks over the years. But when we publicly disclosed a new position in BP stock recently, the blowback from clients and many of our friends in the business was unlike anything we’ve encountered in our careers. It hasn’t shaken our confidence, and neither have the weeks of hysterical headlines, rumors and speculation. We love buying when other investors are panicking, and we were still doing it last week.

Panic there is: BP stock has lost roughly half its value; credit-default swap spreads have widened dramatically; and analysts are furiously cutting their ratings. Seemingly speaking for the whole Street, a well-known energy investment banker said recently, “I don’t think BP is going to last as a company for more than a matter of months.” Politicians at all levels are engaged in ever-more-heated rhetoric.

SO WHY ON EARTH WOULD we own the stock of this pariah company? For two reasons. The stock is extraordinarily cheap, currently trading around five times trailing earnings. (Assuming the dividend is reinstated next year, it also will also have a 10% dividend yield.) And BP is not going bankrupt. It has the fourth-highest revenues of any company in the world, and also earns the fourth-highest profits, trailing only Gazprom, ExxonMobil and Royal Dutch Shell. Profits were depressed in 2009 due to the global economic crisis, but analysts are projecting (and robust first-quarter results affirm) operating profits of around $34 billion ($93 million per day) in 2010 and net income of around $22 billion, consistent with the 2005-2008 average. (These estimates are before Deepwater Horizon costs.) BP is highly likely to be able to cover clean-up, damages, fines and lawsuits, especially since these costs will be paid out over many years.

Everyone is focused on what the total costs to BP might be, without asking the equally important question of when BP might have to make these payments. The clean-up costs will be spread out over the next few years, and the legal liabilities and fines over a much longer period, allowing BP to earn its way out of trouble. In the case of the Exxon Valdez oil spill, the U.S. Supreme Court didn’t make a final ruling on damages until 2008, more than 19 years after the spill.

In owning the stock, we are not defending the company or its CEO. BP appears to have an atrocious safety record, and it wouldn’t surprise us if regulators and the legal system determine that it cut corners on the Deepwater Horizon rig, leading to the tragedy. Compounding this, BP so far has botched both the clean-up and the public relations. We think the company should have to pay for all of the damages it has caused, plus a huge fine. U.S. taxpayers can be thankful that BP is so profitable that it likely will be able to pay for all of the damages it’s caused.

Tilson makes a good case to back up the investment.

I disagree with the first argument; that BP is one of the largest companies and therefore it will not go bankrupt. AIG, Citigroup and many other banks were among the largest financial institutions shortly before their demise. This did not protect them from their massive losses.

However, Tilson in the second paragraph nails the case. BP will not have to pay the liabilities in one lump sum. This will drag out in court for years. In addition, BP can also blame Halliburton and RIG for this disaster. BP cannot be forced to be pay anything until it can be ascertained that they were in fact the guilty party. As of now no one knows for sure if Halliburton and RIG were also involved in this case of negligence.

Tilson states some more good news for BP.

Good days are relative for BP, the company responsible for stopping the largest offshore oil spill in the nation’s history. But the last two days brought moderate signs of progress in the company’s struggle to contain the catastrophe flowing from the floor of the Gulf of Mexico.

BP said Friday that it had captured 25,290 barrels on Thursday of crude oil leaking from the wrecked well. That amount was the most for a single day since the explosion on the Deepwater Horizon rig on April 20, though still not close to the total amount of oil pouring into the gulf each day.

The drilling of one of the relief wells, expected to be the means of sealing the damaged well, came within 200 feet of its destination, BP said.

The Coast Guard, meanwhile, said skimming equipment was being constructed for 2,000 more available vessels through BP’s Vessels of Opportunity program, which hires local boat owners to help clean up the oil.

… By the end of June, the Q4000, together with the Discoverer Enterprise, the vessel with a direct connection to the containment cap on the well, will be joined by a third means of collecting escaping oil: a free-standing riser on the seabed floor. Together, they are expected to be able to collect about 50,000 barrels of oil daily, Mr. Wells said.

By mid-July, BP is planning to put a tighter cap on the well, and establish the second free-standing riser pipe, which can easily be disconnected in the event of a hurricane. By then, there would be four vessels in the gulf collecting oil — with a total capacity of 80,000 barrels a day.

That figure might seem excessive, considering scientists have estimated the maximum flow rate to be only 60,000 barrels a day. But Mr. Wells explained that was to cover all contingencies, “if once we start capturing all the oil, something goes wrong and we’re not capturing any at all,” he said.

Many people state “I knew that I should have bought X stock at X date” . This happened after stocks got very cheap in March 2009. People who bought equities then were richly rewarded. However, many people did not buy stocks, and now say in hindsight they should have (these same people would never buy the stocks if market again dropped to the same price it was at in March 2009).

There are a lot of risks with owning BP. The amount of liabilities it will be on the hook for is still unknown. However, BP right now can offer a buying opportunity akin to the one available on March 6th, 2009.

Disclosure: Long BP