Bill Ackman, of Pershing Square Capital Management, recently published his second quarter letter. As usual, Mr. Ackman discussed individual positions in his portfolio, including Landry's Restaurants, General Growth Properties, and Borders. In addition, he discussed a new position: BP. He is not the first well known investor to take a position in BP, as two other well-known value investors, Whitney Tilson and Bruce Berkowitz have recently created a position in BP's shares. Both Mr. Tilson and Berkowitz are known to be very open in regards to describing the rational behind their investments. While I have not been able to find any information from Bruce Berkowitz in regards to BP, Whitney Tilson does discuss his view on BP in his June Letter to Investors.
From T2 Partners June Letter in regards to BP :
"So why on earth would we own the stock of this pariah company? And if we think it's cheap, why don't we wait for the dust to settle, the panic to stop, and for the outlook to become more clear, and then buy it when it's safer to do so? The second question is easy: becasue by the time the outlook is clear, the stock will be at least 50% higher."
In short, we own the stock for two simple reasons: 1) BP is not going bankrupt. Is is the 4th most profitable company in the world, which means it's highly likely that it will be able to cover the clean-up costs plus all damages/fines/lawsuits. especially since these costs will be spread out over many year; and 2) the stock is extraordinarily cheap, currently trading 5.4x this year's estimated earnings"
"In summary, we think what's happening to BP right now is similar to the overall market in March 2009: the near-term fundamentals are terrible, nobody knows when they will improve, and fear-mongers dominate the headlines. But for investors with courage, conviction, and an outlook longer than a few months, we think this market overreaction is a wonderful buying opportunity."
In the past, Bill Ackman and Whitney Tilson have often shared the same view on a variety of companies, most recently General Growth Properties, a view that both men profited greatly from. However, in this case, their views oppose one another. This is not the first time, however, that this has ocured. Whitney Tilson once recommended Farmer Mac to Bill Ackman as a good long opportunity. After conducting his own research, Bill Ackman ended up shorting the shares of Farmer Mac. During the second quarter, Pershing Square Capital purchased credit default swaps on BP.
From Pershing Square Capital Mangement's Second Quarter Letter:
“In early May, we initiated a short position in BP credit through the purchase of credit default swaps. We began purchasing BP CDS at spreads of 60 basis points per annum and continued to buy protection at levels which brought our average cost to approximately 280 basis points per annum. Current BP CDS trades at approximately 250 basis points per annum and has traded as wide as 600 basis points per annum over the last few months.
Our investment thesis is predicated on our belief that the Gulf disaster has (1) likely permanently impaired the ability of BP to operate effectively in the US, (2) the clean-up costs, penalties, and legal liabilities of the spill will continue to impair the company’s credit for many years, and (3) there is a substantially greater probability than is reflected in the pricing of the CDS that the current liability estimates that have been publicly promulgated materially underestimate the ultimate costs to BP.
In the case of BP, we believe it is unlikely that credit spreads will return to the pre-crises levels for many years, if ever. As such, our downside risk should be limited. On the other hand, if BP is found to be grossly negligent, the Government imposes the contractual penalties required in a case where a driller is found grossly negligent, and clean up costs continue to rise along with the substantial legal and other contingent liabilities, this investment has the potential to be quite profitable."
The current BP situation exemplifies why a market exists. One great investor believes that this is a great long opportunity, while the other believes it is a great short opportunity. Only time will tell which one of these investors will profit. What is certain, however, is the fact that Bill Ackman's position presents a superior risk-reward profile. He is paying only 250 basis points, or 2.5%, per year for what is basically an insurance contract. If the risk of a BP bankruptcy were to rise, the value of these contracts could easily rise more than 10-fold in value. Thus, he can create a position that could significantly impact his fund's performance to the upside, while only risking a few percent or less of the fund's capital.
From T2 Partners June Letter in regards to BP :
"So why on earth would we own the stock of this pariah company? And if we think it's cheap, why don't we wait for the dust to settle, the panic to stop, and for the outlook to become more clear, and then buy it when it's safer to do so? The second question is easy: becasue by the time the outlook is clear, the stock will be at least 50% higher."
In short, we own the stock for two simple reasons: 1) BP is not going bankrupt. Is is the 4th most profitable company in the world, which means it's highly likely that it will be able to cover the clean-up costs plus all damages/fines/lawsuits. especially since these costs will be spread out over many year; and 2) the stock is extraordinarily cheap, currently trading 5.4x this year's estimated earnings"
"In summary, we think what's happening to BP right now is similar to the overall market in March 2009: the near-term fundamentals are terrible, nobody knows when they will improve, and fear-mongers dominate the headlines. But for investors with courage, conviction, and an outlook longer than a few months, we think this market overreaction is a wonderful buying opportunity."
In the past, Bill Ackman and Whitney Tilson have often shared the same view on a variety of companies, most recently General Growth Properties, a view that both men profited greatly from. However, in this case, their views oppose one another. This is not the first time, however, that this has ocured. Whitney Tilson once recommended Farmer Mac to Bill Ackman as a good long opportunity. After conducting his own research, Bill Ackman ended up shorting the shares of Farmer Mac. During the second quarter, Pershing Square Capital purchased credit default swaps on BP.
From Pershing Square Capital Mangement's Second Quarter Letter:
“In early May, we initiated a short position in BP credit through the purchase of credit default swaps. We began purchasing BP CDS at spreads of 60 basis points per annum and continued to buy protection at levels which brought our average cost to approximately 280 basis points per annum. Current BP CDS trades at approximately 250 basis points per annum and has traded as wide as 600 basis points per annum over the last few months.
Our investment thesis is predicated on our belief that the Gulf disaster has (1) likely permanently impaired the ability of BP to operate effectively in the US, (2) the clean-up costs, penalties, and legal liabilities of the spill will continue to impair the company’s credit for many years, and (3) there is a substantially greater probability than is reflected in the pricing of the CDS that the current liability estimates that have been publicly promulgated materially underestimate the ultimate costs to BP.
In the case of BP, we believe it is unlikely that credit spreads will return to the pre-crises levels for many years, if ever. As such, our downside risk should be limited. On the other hand, if BP is found to be grossly negligent, the Government imposes the contractual penalties required in a case where a driller is found grossly negligent, and clean up costs continue to rise along with the substantial legal and other contingent liabilities, this investment has the potential to be quite profitable."
The current BP situation exemplifies why a market exists. One great investor believes that this is a great long opportunity, while the other believes it is a great short opportunity. Only time will tell which one of these investors will profit. What is certain, however, is the fact that Bill Ackman's position presents a superior risk-reward profile. He is paying only 250 basis points, or 2.5%, per year for what is basically an insurance contract. If the risk of a BP bankruptcy were to rise, the value of these contracts could easily rise more than 10-fold in value. Thus, he can create a position that could significantly impact his fund's performance to the upside, while only risking a few percent or less of the fund's capital.
