Anadarko Petroleum Corporation is one of the largest independent oil and gas exploration companies in the world. Anadarko was invited by BP in late 2009 to be a minority nonoperating partner in the development of Mississippi Canyon block 252, better known as the Macondo Well. Pursuant to their Joint Operating Agreement (“JOA”), Anadarko accepted liability for all damages, costs and claims related to activities under the JOA in proportion to its 25% economic interest in the well, except in the event liability results from the gross negligence or willful misconduct by the operator, BP. Subsequent to the explosion of the Deepwater Horizon platform and the discovery of oil leaking from the Macondo well into the Gulf of Mexico, Anadarko’s share price declined from ~$73 pre‐incident to a low of $35, while spreads on the company’s debt securities (which carried investment grade ratings pre‐incident) increased from ~100 bps to nearly 700 bps.
The decline in the value of the securities was precipitated by 1) uncertainty over the magnitude of the total claims, cleanup costs, and fines related to the spill, as well as Anadarko’s share of the liabilities, 2) uncertainty over the timing of the payments related to the spill (and concerns about liquidity), 3) concerns over the potential impairment of Anadarko’s Gulf of Mexico assets in the wake of the drilling moratorium, and 4) forced selling by investment grade bond holders after Moody’s downgraded the bonds to “junk”.
We initiated a position in the debt securities in June and July of 2010 at yields to maturity of 8 to 9.5%, expecting all-in returns via interest and capital appreciation of 20 to 30% based on the view that the market overreacted to the impact of the spill and potential liabilities. We believed that investors were ignoring the long duration of the cash outflows related to spill liabilities (NPV effect) as well as the tax deductibility of those expenses. Our analysis suggested that the “worst-case”liability figures for BP included punitive damages and criminal fines that Anadarko would not be required to share in any scenario, and Anadarko will likely not have to pay its 25% share of the liabilities due to a finding of gross negligence on the part of BP or, more plausibly, a settlement with BP (a scenario with potent political tailwinds). Finally, we knew the Company’s intent is to be an investment grade company, and so regardless of the ultimate liability, the Company would take actions (equity raises, asset sales, Capex reductions) to reattain investment grade status.
Since our investment, the majority of the securities related to the Macondo tragedy have appreciated significantly, including Anadarko’s bonds. Our analysis was correct and in hindsight, investors could have generated similar returns by investing in anything “Macondo‐related” (e.g. RIG, BP and Anadarko equities). However, Anadarko bonds offered similar upside to the aforementioned equity securities but with effectively zero downside in the event that either our thesis on the severity of the spill was incorrect or there was a material decline in oil and/or natural gas prices, and so we delivered excellent risk-adjusted returns.
In August, we participated in the IPO of NXP Semiconductors NV, a leading semiconductor manufacturer emerging from a 2006 LBO led by KKR, Silver Lake, Bain and Apax. We had successfully participated in the NXP story via its distressed debt in late 2009, and were prepared for the IPO, which came at a very attractive valuation of roughly 5.5x estimated 2011 EPS. The company is in the final stages of completing a substantial operational and capital structure restructuring, which is driving strong free cash flow, rapid deleveraging and attractive new opportunities like a leadership position (>50% market share) in Near Field Communications, a fast emerging mobile payment technology being adopted by Google Android, Nokia and Blackberry.
Despite a strong recent run in the shares, limited familiarity and misconceptions leave it trading at a 50% discount to peer P/E and FCF multiples and lagging the performance of other comparably levered, post‐LBO IPOs such as Sensata and Avago. As NXP’s growth, profitability and cash flow attributes (it will generate close to $3 in 2011 FCF) become better understood, we see substantial upside in the name.
ProSieben is one of Europe’s largest media operators, with an attractive 40% share of the German free-to-air television market. This investment fits one of our favorite framework profiles -- a situation with a confusing capital and ownership structure, and a distressed valuation exacerbated by equity investors who misunderstood the credit story and credit investors who ignored the equity angle.
Third Point began accumulating a stake in the company’s preference shares almost a year ago when they traded at<6x 2010 PE, according to our forecasts. At the time, the distressed multiple was due to the company’s extensive financial leverage and the highly levered and distressed holding company, Lavena, which was owned by a private equity consortium and held the majority of the company’s voting stock. At the height of the buyout boom in 2007, when the share price was ~€29, the private equity firms raised a substantial amount of debt at Lavena to leverage their stake in ProSieben. In 2009, as the stock price fell sharply due to concerns over the operating company’s high leverage and expectations of a significant decline in earnings, the loan to value at Lavena began to rise precipitously. These worries caused the stock of ProSieben, the Operating Company, to trade as low as €1.
Our diligence suggested that the vicious circle which caused the stock to fall could be reversed into a virtuous one as our analysis suggested that a) the fundamentals of the business coming out of 2009 were improving and earnings had troughed, b) as credit investors, we understood the Lavena loan document to be covenant‐lite and also believed the private equity firms were committed to the investment, and c) the shares were orphaned by equity investors who couldn’t understand the credit angle and ignored by credit investors who were restricted from buying the equity. This led us to accumulate not only a position in the preference shares at €7, but also in the senior portion of the Lavena Holding Company loan at €0.55 cents. Today ProSieben preference shares trade at ~€20 and the senior loan trades at €0.82 cents. We believe there is still equity upside from the price today as the multiple rerating has been to 10x PE only, still cheap for an asset of this type and quality.
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