Value Investing

Asymmetrical Payoff & Case Study: Petrobras (Part 2)

Having covered the basic aspects of asymmetrical payoff previously (LINK), we will be covering our investment thesis for Petrobras. Petrobras caught our attention during the period when the oil crisis resulted in many investors panicking – selling off companies that were dependent on oil. Additionally, they were being investigated in a massive scandal in Brazil. From its peak in 2010, Petrobras was a USD 230billion market capitalisation company and currently, it has a market capitalisation of USD 43billion, translating to a loss of roughly 80% or USD 187billion.

Asymmetrical Payoff & Case Study: Petrobras (Part 2)

Source: Yahoo Finance – Petrobras Stock Price

Investment Thesis

Initially, our investment thesis was dependent on the reversion of oil prices. How do we deem what is a fair price for oil? However, after analysing the history behind the correlation between oil prices and companies, it dawned upon us that ultimately, there is always a replacement value for the oil rigs (LINK). When looking at oil companies, we should not be too focused on the direction the price of oil is heading but rather the replacement value of the oil rigs. At the point of investment, Petrobras was trading roughly at a P/B of 0.3x.

Secondly, since the scandal, most of the negative news have been priced in and we see the Brazilian Government and Company Management taking steps in the right direction – changing of CEO, assessing the fair value of their assets carried out by global firms internationally recognised as independent evaluators, trying to get the Q4 earnings results signed off by auditors etc. We viewed this as the turning point of a down cycle for the company.

Source: Petrobras Q3 Non-Reviewed Information



Lastly as stated within the Q3 Non-Reviewed Information, Petrobras’s cash position or operating cash flow will not be affected by any adjustments arising from corruption or any other related to the amount of its assets. Hence, based on management’s estimates and assumptions, it showed how no funding is required to keep the company solvent. This can be seen in the

following 2 slides.


Having explained the investment thesis for Petrobras, the crux would be risk management as explained in Part 1. Given the nature of risk of such an investment, we did not allocate a huge percentage of our portfolio in such a company, due to a possible permanent loss of capital. As an additional point to note, one can use a put option to further hedge their downside. Further limiting the downside potential, it creates a larger asymmetrical payoff. Consider this scenario, where after factoring in the cost of a long put option, it results in a downside potential of 30%. However, if the company is able to turn itself around and start churning out positive FCF once more, we stand to make more than 1-2x our invested amount. Suppose we limit our invested amount to 1% of our AUM. This means that in the worse case scenario, we will only have 0.7% left, while in the ideal scenario, our 1% could have become 2-3% of our AUM. Lastly, it would be the point on probability. Given that Petrobras is a 50% state owned company and the Brazilian Government taking the right measures, we felt that the probability of a downside potential to be rather low. Hence, we found such a asymmetrical payoff on Petrobras not only interesting but an attractive investment.

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Disclosure: The authors are no longer invested in Petrobras

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