Latepost How Depression Tin Plough Over Notice Yous Go? Doing The Petrobras Limbo!
H5N1 few months ago, I suggested that investors venture where it is darkest, the under regions of the corporate the world where province risk, commodity opportunity as well as companionship opportunity all collide to create investing quicksand. I all the same ain the 2 companies that I highlighted inwards that post, Vale as well as Lukoil, as well as receive got no regrets, fifty-fifty though I receive got lost money on both. At the fourth dimension of the post, I was asked why I had non picked Brazil’s other commodity colossus, Petrobras, every bit my companionship to value (and invest in) as well as I dodged the question. The intelligence from the lastly few days provides a partial answer, but I remember that the Petrobras experience, painful though it mightiness receive got been for some investors, provides an representative of the costs as well as benefits of political patronage.
Petrobras: H5N1 Short History
Petrobras was founded inwards 1953 every bit the Brazilian regime fossil oil company, as well as for the commencement few decades of its life, it was run every bit a government-owned companionship from its headquarters inwards Rio De Janeiro. Until 1997, it had a legal monopoly on fossil oil production as well as distribution inwards Brazil, when the domestic marketplace was opened upwards to unusual fossil oil producers. Petrobras was listed every bit a world companionship inwards 1997 on the Sao Paulo telephone substitution as well as every bit a depository receipt on the New York Stock Exchange presently after. The arc of fortunes for the companionship tin live traced inwards the changes inwards its marketplace capitalization over time, reported inwards the U.S.A. dollars inwards the figure below:
 |
| Market Capitalization & Enterprise Value at terminate of each year |
In the lastly decade, Petrobras has seen both highs as well as lows, becoming the 5th largest companionship inwards the world, inwards terms of marketplace capitalization, inwards 2011 as well as thence seeing a acute drib off inwards marketplace prices inwards the years since. To empathize where Petrobras is at i time as well as to brand sense of where it is going, yous receive got to await at both its ascent inwards the lastly decade as well as its autumn inwards this one.
The ascent of Petrobras from modest emerging marketplace fossil oil companionship to global giant betwixt 2002 as well as 2010 tin live traced to 3 factors. The commencement was the regain of major novel reserves inwards Brazil inwards the early on part of the lastly decade, which catapulted the companionship towards the top of the listing of companies amongst proven reserves. The fact that these reserves would live expensive to railroad train was mitigated past times a minute development, which was the sustained surge inwards fossil oil prices to triple digit levels for much of the period, making them viable. The tertiary was an overall reduction inwards Brazilian province opportunity from the stratospheric levels of 2001 (when the province default spread for Brazil reached 14.34%, simply earlier the election of Lula Da Silva every bit President) to 1.43% inwards 2010, when Brazil looked similar it had made the jump to almost-developed marketplace status. In 2010, the companionship signaled that its arrival inwards global markets as well as its ambitions to live fifty-fifty to a greater extent than past times raising $72.8 billion from equity markets.
The hubris that led to the world offering may receive got been the trigger for the subsequent autumn of the company, which has been dizzying because of the magnitude of the decline, as well as its speed. After peaking at a marketplace capitalization unopen to $244 billion inwards 2010, the companionship has managed to lose a fiddling fighting to a greater extent than than $200 billion inwards value since, putting it inwards rarefied companionship amongst other champion value destroyers over time. While a large portion of the blame for the refuse inwards the lastly few months (especially since September 2014) tin live attributed to the drib inwards fossil oil prices, notation that Petrobras has already managed to destroy $160 billion inwards value prior to that betoken inwards time.
Petrobras: Governance Structure
To empathize the Petrobras story, yous receive got to start amongst an assessment how the companionship is structured. When the regime privatized the company, it did thence amongst the objective of raising working capital missive of the alphabet for its treasury but it did non desire to unloosen command of the companionship to the shareholders who bought shares inwards the company. Using "national interest" every bit a shield, the regime devised a game where it would live able to command the company, field raising billions inwards working capital missive of the alphabet from investors. The the world for that game, as well as it is non unique to Petrobras, was to create 2 classes of shares, i amongst voting rights (common shares) as well as i without (called preferred shares, inwards an Orwellian twist), as well as offering the latter primarily to investors. The regime retains command of to a greater extent than than 50% of the voting shares inwards the companionship as well as some other 11% is controlled past times entities (like the Brazilian Development Bank, BNDES, as well as Brazil's sovereign wealth fund) over which the regime has effective control. Not quite satisfied amongst this rigging of the game, the regime also retains veto powerfulness (a golden share) over major decisions.
Using this command structure, the regime has created the ultimate safe postage board, whose alone role has been to protect the government's interests (or to a greater extent than just the politicians who comprise the regime at the time) at all costs. Brazilian companionship police does require that the minority shareholders (anybody but the government) receive got board representatives, but every bit political payoffs or worse. Between 2009 as well as 2014, Petrobras stepped upwards its working capital missive of the alphabet expenditures as well as exploration costs to to a greater extent than than 35% of revenues, good higher upwards the 15-20% invested past times other integrated fossil oil companies, field seeing its render on working capital missive of the alphabet drib to 5% (even every bit fossil oil prices stayed at $100+/barrel for the mass of the period).
Step 2 - Grow, baby, grow, as well as profitability live damned
Petrobras has grown its revenues from $17.4 billion inwards 1997 to $135.8 billion inwards 2014 as well as displaced Exxon Mobil every bit the largest global fossil oil producer inwards the tertiary quarter of 2014, field letting turn a profit margins drib dramatically. The regime contributes to this dysfunctional increment past times putting pressure level on the companionship to articles/SB10001424052702304017204579226460458417366">sell gasoline at subsidized prices to Brazilian motorcar owners.
Step 3 - Pay dividends similar a regulated utility (even though yous are not)
Petrobras has a history of paying large dividends, partly because it had the cash flows to pay those dividends inwards the 1990s as well as partly to supports it voting portion structure. The preferred (non-voting) shares that the companionship has used to nurture capital, without giving upwards control, come upwards amongst dividend payout requirements that are onerous, if yous receive got increment ambitions.
Step iv - Borrow money to embrace the cash deficit
If yous desire to eat your cake (by investing large amounts to generate growth) as well as receive got it also (while paying large dividends), the alone agency to brand upwards the deficit is to nurture fresh capital. In 2010, Petrobras did nurture $79 billion inwards fresh equity but it has been theme upon debt every bit its primarily financing inwards every other year. As a consequence, Petrobras had total debt outstanding of $135 billion at the terminate of 2014, to a greater extent than than whatever other fossil oil companionship inwards the world.
Step 5 - Destroy value (Mission accomplished)
If yous over invest as well as grow without heeding profitability, field paying dividends yous cannot afford to pay as well as borrowing much to a greater extent than than yous should be, yous receive got created the perfect tempest for value destruction. In fact, the agency Petrobras has been run thence defies mutual sense as well as commencement principles inwards corporate finance, that if I were a conspiracy theorist, I would live almost laid to purchase into the notion that this is part of a diabolical innovation to destroy the companionship hatched past times evil geniuses somewhere. I receive got learned through difficult experience, though, that yous should non attribute to malevolence what tin live explained past times greed, self-dealing as well as bad incentive systems.
It is worth noting that none of the numbers inwards the lastly department tin live attributed to the drib inwards fossil oil prices. In the most recent twelve calendar month information that yous run across inwards these graphs stand upwards for the twelvemonth ending September 30, 2014, as well as the average fossil oil cost during that twelvemonth exceeded $100/barrel.The regime of Brazil, working through the administration that they installed at Petrobras, receive got pulled off the amazing feat of destroying to a greater extent than than $200 billion inwards value amongst no assist from outside.
A Contrarian Bet?
When a companionship falls every bit fast as well as every bit far every bit Petrobras has, it attracts the interests of contrarian investors as well as the companionship looks attractive on the surface, at to the lowest degree using some conventional multiples.
Petrobras looks real cheap, at to the lowest degree using equity multiples (PE as well as Price/Book) but the results are mixed amongst enterprise value multiples.
All of these multiples are affected past times the fact that fossil oil prices receive got dropped dramatically since the most recent fiscal statements as well as that the earnings numbers, inwards particular, volition dive inwards the coming quarters. Given that Petrobras was already reporting sagging profits, earlier the fossil oil cost drop, I am almost afraid to remember of what the numbers volition await similar at today's fossil oil prices (which are closer to $50)., but I volition endeavor anyway. Looking at the annual revenues over fourth dimension at the companionship as well as relating them to the average fossil oil prices each year, hither is what I find:
The ascent of Petrobras from modest emerging marketplace fossil oil companionship to global giant betwixt 2002 as well as 2010 tin live traced to 3 factors. The commencement was the regain of major novel reserves inwards Brazil inwards the early on part of the lastly decade, which catapulted the companionship towards the top of the listing of companies amongst proven reserves. The fact that these reserves would live expensive to railroad train was mitigated past times a minute development, which was the sustained surge inwards fossil oil prices to triple digit levels for much of the period, making them viable. The tertiary was an overall reduction inwards Brazilian province opportunity from the stratospheric levels of 2001 (when the province default spread for Brazil reached 14.34%, simply earlier the election of Lula Da Silva every bit President) to 1.43% inwards 2010, when Brazil looked similar it had made the jump to almost-developed marketplace status. In 2010, the companionship signaled that its arrival inwards global markets as well as its ambitions to live fifty-fifty to a greater extent than past times raising $72.8 billion from equity markets.
The hubris that led to the world offering may receive got been the trigger for the subsequent autumn of the company, which has been dizzying because of the magnitude of the decline, as well as its speed. After peaking at a marketplace capitalization unopen to $244 billion inwards 2010, the companionship has managed to lose a fiddling fighting to a greater extent than than $200 billion inwards value since, putting it inwards rarefied companionship amongst other champion value destroyers over time. While a large portion of the blame for the refuse inwards the lastly few months (especially since September 2014) tin live attributed to the drib inwards fossil oil prices, notation that Petrobras has already managed to destroy $160 billion inwards value prior to that betoken inwards time.
Petrobras: Governance Structure
To empathize the Petrobras story, yous receive got to start amongst an assessment how the companionship is structured. When the regime privatized the company, it did thence amongst the objective of raising working capital missive of the alphabet for its treasury but it did non desire to unloosen command of the companionship to the shareholders who bought shares inwards the company. Using "national interest" every bit a shield, the regime devised a game where it would live able to command the company, field raising billions inwards working capital missive of the alphabet from investors. The the world for that game, as well as it is non unique to Petrobras, was to create 2 classes of shares, i amongst voting rights (common shares) as well as i without (called preferred shares, inwards an Orwellian twist), as well as offering the latter primarily to investors. The regime retains command of to a greater extent than than 50% of the voting shares inwards the companionship as well as some other 11% is controlled past times entities (like the Brazilian Development Bank, BNDES, as well as Brazil's sovereign wealth fund) over which the regime has effective control. Not quite satisfied amongst this rigging of the game, the regime also retains veto powerfulness (a golden share) over major decisions.
 |
| Shareholding every bit of Feb 2015 |
Step 2 - Grow, baby, grow, as well as profitability live damned
Petrobras has grown its revenues from $17.4 billion inwards 1997 to $135.8 billion inwards 2014 as well as displaced Exxon Mobil every bit the largest global fossil oil producer inwards the tertiary quarter of 2014, field letting turn a profit margins drib dramatically. The regime contributes to this dysfunctional increment past times putting pressure level on the companionship to articles/SB10001424052702304017204579226460458417366">sell gasoline at subsidized prices to Brazilian motorcar owners.
Step 3 - Pay dividends similar a regulated utility (even though yous are not)
Petrobras has a history of paying large dividends, partly because it had the cash flows to pay those dividends inwards the 1990s as well as partly to supports it voting portion structure. The preferred (non-voting) shares that the companionship has used to nurture capital, without giving upwards control, come upwards amongst dividend payout requirements that are onerous, if yous receive got increment ambitions.
Step iv - Borrow money to embrace the cash deficit
If yous desire to eat your cake (by investing large amounts to generate growth) as well as receive got it also (while paying large dividends), the alone agency to brand upwards the deficit is to nurture fresh capital. In 2010, Petrobras did nurture $79 billion inwards fresh equity but it has been theme upon debt every bit its primarily financing inwards every other year. As a consequence, Petrobras had total debt outstanding of $135 billion at the terminate of 2014, to a greater extent than than whatever other fossil oil companionship inwards the world.
Step 5 - Destroy value (Mission accomplished)
If yous over invest as well as grow without heeding profitability, field paying dividends yous cannot afford to pay as well as borrowing much to a greater extent than than yous should be, yous receive got created the perfect tempest for value destruction. In fact, the agency Petrobras has been run thence defies mutual sense as well as commencement principles inwards corporate finance, that if I were a conspiracy theorist, I would live almost laid to purchase into the notion that this is part of a diabolical innovation to destroy the companionship hatched past times evil geniuses somewhere. I receive got learned through difficult experience, though, that yous should non attribute to malevolence what tin live explained past times greed, self-dealing as well as bad incentive systems.
A Contrarian Bet?
When a companionship falls every bit fast as well as every bit far every bit Petrobras has, it attracts the interests of contrarian investors as well as the companionship looks attractive on the surface, at to the lowest degree using some conventional multiples.
All of these multiples are affected past times the fact that fossil oil prices receive got dropped dramatically since the most recent fiscal statements as well as that the earnings numbers, inwards particular, volition dive inwards the coming quarters. Given that Petrobras was already reporting sagging profits, earlier the fossil oil cost drop, I am almost afraid to remember of what the numbers volition await similar at today's fossil oil prices (which are closer to $50)., but I volition endeavor anyway. Looking at the annual revenues over fourth dimension at the companionship as well as relating them to the average fossil oil prices each year, hither is what I find:
Revenues at Petrobras = -4,619 1000000 + 1276 (Average Oil cost during year) R squared = 92%
Thus, if yous assume that the electrical flow fossil oil cost of $51.69 is unopen to the average for this year, the normalized revenues for Petrobras volition live $61.3 billion, a drib off of nigh 55% from the $135.8 billion revenues inwards the 12 months ending September 30, 2014. Revenues at Petrobras = -4,619 1000000 + 1276 (51.69) = $61,337 1000000 or $61.3 billion
If yous apply the operating margin of 10.82% that Petrobras reported inwards the trailing 12 months to these revenues, yous brand it at an operating income of $6,638 million, prior to taxes. At that flat of earnings, the value that I acquire for the companionship is $62.4 billion, good below the $135.1 billion owed past times the company, making its equity worth nothing. In the matrix below, I await at the value per portion under dissimilar combinations of base of operations twelvemonth income (ranging from $6,638 1000000 at the depression to $28.7 billion at the high) as well as render on invested working capital missive of the alphabet on novel investments (again ranging from a depression of 2.67%, amongst income normalized for depression fossil oil prices, to 13.36% every bit the high): |
| Assuming no high increment period, stable increment charge per unit of measurement of 2% as well as cost of working capital missive of the alphabet of 11.17%. Adding a high increment menses reduces value inwards all the render on working capital missive of the alphabet scenarios, except i (average over lastly 10 years) |
The carmine numbers stand upwards for the dead zone, where the value of the problem organisation is less than the debt outstanding as well as they dominate the table. In spite of the reckless abandon shown past times its management, at that spot remain some vivid spots, if yous are an optimist. The commencement is that the companionship is i of the largest fossil oil producers inwards the the world as well as if fossil oil prices rebound, they volition run across a jump inwards revenues. The minute is that the exploration as well as investments over the lastly decade receive got given the companionship the fifth largest proven fossil oil reserves inwards the world, though the proportion of these reserves that volition live feasible at today's fossil oil prices is opened upwards to question. The tertiary is that if the Brazilian regime stops pulling the strings as well as administration stops its self destructive behavior, turn a profit margins as well as returns volition improve. In the most optimistic spin, yous tin assume that Petrobras volition live able to continue its trailing 12-month intact at $135.8 billion, improve its operating margin to the 21.1% that it earned inwards 2010 as well as its render on working capital missive of the alphabet to 13.36% (10-year average), field reducing its debt ratio to 43.5% (average over lastly 5 years). With those assumptions, which edge on fantasy, Petrobras would live worth $8.11/share (R$ 22.55/share) good higher upwards the electrical flow stock cost of $3.28/share (R$ 9.12/share). You are welcome to endeavor out dissimilar combinations of your assumptions inwards this spreadsheet as well as run across what yous get.
Unsolicited (and maybe unwelcome) advice for a novel CEO
H5N1 span of weeks ago, Ms. Maria das Gracas Foster, Petrobras CEO since Feb 2012, articles/petrobras-ceo-and-5-other-executives-resign-1423055419">stepped down, as well as the Brazilian regime announced that it has articles/banco-do-brasil-chief-under-consideration-for-top-petrobras-post-1423229592">chosen Mr. Aldemir Bendine, erstwhile caput of Banco exercise Brazil, every bit the side past times side CEO. The marketplace response was almost universally negative, partly because Mr. Bendine does non receive got whatever sense inwards the fossil oil problem organisation as well as partly because at that spot is no trust left inwards the Brazilian government. I exercise non know Mr. Bendine as well as it would live unfair of me to tar him every bit a regime stooge, simply because he was appointed past times the government. In fact, I am willing to non alone cutting him some slack but to also furnish advice on what he should exercise inwards the coming weeks. Here are my suggestions:
- Hire a main operating officeholder who knows the fossil oil problem organisation as well as plough over operating responsibilities to him.
- Fire anyone inwards the top administration who has whatever political connections. That may acquire out lots of empty offices inwards Petrobras headquarters, but less impairment volition live done past times no i existence inwards those offices than the electrical flow occupants.
- Side amongst directors for the minority stockholders as well as force for a to a greater extent than independent, accountable board.
- Refuse to become along amongst the cap on gasoline prices for Brazilian consumers, a subsidy that has already cost the companionship $20-$25 billion betwixt 2011 as well as 2013. With fossil oil prices low, the consumer backlash volition live bearable.
- Push openly for a motion to i degree of shares amongst equal voting rights. Accompany this activity past times cutting dividends to zero.
- Clean upwards the investment procedure amongst less auto-pilot exploration, production that is inwards line amongst fossil oil prices as well as less focus on growth, for the sake of growth.
- Start paying downward your debt.
What is the worst that tin come about to you? If the regime is assail a path of self-destruction, yous volition live fired. If that happens, article of apparel it every bit a badge of honor, since your reputation volition live enhanced as well as yous volition emerge looking similar a hero. If yous become along amongst the condition quo, yous volition preside over the terminal devastation of what was Brazil’s crown gem as well as human face upwards the same fate every bit articles/petrobras-ceo-and-5-other-executives-resign-1423055419">your predecessor. Unless the novel CEO tin come upwards up amongst a agency to remake the company, my estimate is that, at to the lowest degree for the side past times side few months, hither is the vocal that volition live playing out inwards the market:
Final Thoughts
There are e'er lessons to live learned from every calamity as well as Petrobras qualifies every bit a calamity. The commencement is to recognize that at that spot every ground to live skeptical when politicians claim "national interest" as well as meddle incessantly inwards world corporations. In most cases, what yous receive got are political interests which may or may non coincide amongst national interests, where elected politicians as well as regime officials exercise stockholder money to advance their standing. The minute is that those who receive got labeled "value maximization" every bit the "dumbest idea" as well as pushed for stakeholder wealth maximization, a meaningless as well as misguided objective that alone strategists as well as Davos organizers observe attractive, every bit an alternative, should receive got a unopen await at Petrobras every bit a instance study of stakeholder wealth maximization gone amok. In the lastly 5 years, Petrobras has enriched countless politicians as well as politically connected businesses, subsidized Brazilian motorcar owners as well as provided jobs to tens of thousands of fossil oil workers, leaving stockholders on the exterior looking in. Anyone who argues that this is a cyberspace expert for Brazil has clearly non grasped the impairment that has been done to the province inwards the global marketplace house past times this fiasco.
Corruption update: I receive got been asked past times many of yous every bit to why receive got sidestepped the corruption stories that receive got been swirling some the company. I did so, non because I desire to avoid contestation (which I don't brain at all) but because I sentiment that at to the lowest degree inwards this case, existence subtle delivers the message nigh political game playing meliorate than animal force. At Petrobras, I process corruption every bit a actually bad investment amongst horrible returns to stockholders, but I believe that amongst its administration structure, the companionship was destined for trouble, as well as that the corruption simply greased the skids.
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