A few months ago, I suggested that investors venture where it is darkest, the nether regions of the corporate world where country risk, commodity risk and company risk all collide to create investing quicksand. I still own the two companies that I highlighted in that post, Vale and Lukoil, and have no regrets, even though I have lost money on both. At the time of the post, I was asked why I had not picked Brazil’s other commodity colossus, Petrobras, as my company to value (and invest in) and I dodged the question. The news from the last few days provides a partial answer, but I think that the Petrobras experience, painful though it might have been for some investors, provides an illustration of the costs and benefits of political patronage.
Petrobras: A Short History
Petrobras was founded in 1953 as the Brazilian government oil company, and for the first few decades of its life, it was run as a government-owned company from its headquarters in Rio De Janeiro. Until 1997, it had a legal monopoly on oil production and distribution in Brazil, when the domestic market was opened up to foreign oil producers. Petrobras was listed as a public company in 1997 on the Sao Paulo exchange and as a depository receipt on the New York Stock Exchange soon after. The arc of fortunes for the company can be traced in the changes in its market capitalization over time, reported in US dollars in the figure below:
 |
| Market Capitalization & Enterprise Value at end of each year |
In the last decade, Petrobras has seen both highs and lows, becoming the fifth largest company in the world, in terms of market capitalization, in 2011 and then seeing a precipitous drop off in market prices in the years since. To understand where Petrobras is now and to make sense of where it is going, you have to look at both its rise in the last decade and its fall in this one.
The rise of Petrobras from minor emerging market oil company to global giant between 2002 and 2010 can be traced to three factors. The first was the discovery of major new reserves in Brazil in the early part of the last decade, which catapulted the company towards the top of the list of companies with proven reserves. The fact that these reserves would be expensive to develop was mitigated by a second development, which was the sustained surge in oil prices to triple digit levels for much of the period, making them viable. The third was an overall reduction in Brazilian country risk from the stratospheric levels of 2001 (when the country default spread for Brazil reached 14.34%, just before the election of Lula Da Silva as President) to 1.43% in 2010, when Brazil looked like it had made the leap to almost-developed market status. In 2010, the company signaled that its arrival in global markets and its ambitions to be even more by raising $72.8 billion from equity markets.
The hubris that led to the public offering may have been the trigger for the subsequent fall of the company, which has been dizzying because of the magnitude of the decline, and its speed. After peaking at a market capitalization close to $244 billion in 2010, the company has managed to lose a little bit more than $200 billion in value since, putting it in rarefied company with other champion value destroyers over time. While a large portion of the blame for the decline in the last few months (especially since September 2014) can be attributed to the drop in oil prices, note that Petrobras has already managed to destroy $160 billion in value prior to that point in time.
Petrobras: Governance Structure
To understand the Petrobras story, you have to start with an assessment how the company is structured. When the government privatized the company, it did so with the objective of raising capital for its treasury but it did not want to release control of the company to the shareholders who bought shares in the company. Using "national interest" as a shield, the government devised a game where it would be able to control the company, while raising billions in capital from investors. The basis for that game, and it is not unique to Petrobras, was to create two classes of shares, one with voting rights (common shares) and one without (called preferred shares, in an Orwellian twist), and offering the latter primarily to investors. The government retains control of more than 50% of the voting shares in the company and another 11% is controlled by entities (like the Brazilian Development Bank, BNDES, and Brazil's sovereign wealth fund) over which the government has effective control. Not quite satisfied with this rigging of the game, the government also retains veto power (a golden share) over major decisions.
Using this control structure, the government has created the ultimate rubber stamp board, whose only role has been to protect the government's interests (or more precisely the politicians who comprise the government at the time) at all costs. Brazilian company law does require that the minority shareholders (anybody but the government) have board representatives, but as this story makes clear, these directors are not just ignored but face retaliation for raising basic questions about governance. To be fair to Ms. Dilma Rousseff, government interference has always been the case in Petrobras, and her predecessors have been just as guilty of treating Petrobras as a piggybank and political patronage machine, as she has. Lula, who stepped down with great fanfare, as president just a few years ago was equally interventionist, but high oil prices provided the buffer that protected him from the fallout.
The rise of Petrobras from minor emerging market oil company to global giant between 2002 and 2010 can be traced to three factors. The first was the discovery of major new reserves in Brazil in the early part of the last decade, which catapulted the company towards the top of the list of companies with proven reserves. The fact that these reserves would be expensive to develop was mitigated by a second development, which was the sustained surge in oil prices to triple digit levels for much of the period, making them viable. The third was an overall reduction in Brazilian country risk from the stratospheric levels of 2001 (when the country default spread for Brazil reached 14.34%, just before the election of Lula Da Silva as President) to 1.43% in 2010, when Brazil looked like it had made the leap to almost-developed market status. In 2010, the company signaled that its arrival in global markets and its ambitions to be even more by raising $72.8 billion from equity markets.
The hubris that led to the public offering may have been the trigger for the subsequent fall of the company, which has been dizzying because of the magnitude of the decline, and its speed. After peaking at a market capitalization close to $244 billion in 2010, the company has managed to lose a little bit more than $200 billion in value since, putting it in rarefied company with other champion value destroyers over time. While a large portion of the blame for the decline in the last few months (especially since September 2014) can be attributed to the drop in oil prices, note that Petrobras has already managed to destroy $160 billion in value prior to that point in time.
Petrobras: Governance Structure
To understand the Petrobras story, you have to start with an assessment how the company is structured. When the government privatized the company, it did so with the objective of raising capital for its treasury but it did not want to release control of the company to the shareholders who bought shares in the company. Using "national interest" as a shield, the government devised a game where it would be able to control the company, while raising billions in capital from investors. The basis for that game, and it is not unique to Petrobras, was to create two classes of shares, one with voting rights (common shares) and one without (called preferred shares, in an Orwellian twist), and offering the latter primarily to investors. The government retains control of more than 50% of the voting shares in the company and another 11% is controlled by entities (like the Brazilian Development Bank, BNDES, and Brazil's sovereign wealth fund) over which the government has effective control. Not quite satisfied with this rigging of the game, the government also retains veto power (a golden share) over major decisions.
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| Shareholding as of February 2015 |
A Roadmap for Value Destruction
Just as looking at companies that have created significant amounts of value over time is enlightening because of the insights you get into what companies do right, Petrobras should become a case study for the opposite reason. Put in brutally direct terms, if you were given a valuable business and given the perverse objective of destroying it completely and quickly, you should replicate what Petrobras has done in five steps.
Step 1 - Invest first, worry about returns later (perhaps never)
Invest massive amounts of money in new investments, with little heed to returns on these investments, and often with the intent of delivering political payoffs or worse. Between 2009 and 2014, Petrobras stepped up its capital expenditures and exploration costs to more than 35% of revenues, well above the 15-20% invested by other integrated oil companies, while seeing its return on capital drop to 5% (even as oil prices stayed at $100+/barrel for the bulk of the period).
Step 2 - Grow, baby, grow, and profitability be damned
Petrobras has grown its revenues from $17.4 billion in 1997 to $135.8 billion in 2014 and displaced Exxon Mobil as the largest global oil producer in the third quarter of 2014, while letting profit margins drop dramatically. The government contributes to this dysfunctional growth by putting pressure on the company to sell gasoline at subsidized prices to Brazilian car owners.
Step 3 - Pay dividends like a regulated utility (even though you are not)
Petrobras has a history of paying large dividends, partly because it had the cash flows to pay those dividends in the 1990s and partly to supports it voting share structure. The preferred (non-voting) shares that the company has used to raise capital, without giving up control, come with dividend payout requirements that are onerous, if you have growth ambitions.
Step 4 - Borrow money to cover the cash deficit
If you want to eat your cake (by investing large amounts to generate growth) and have it too (while paying large dividends), the only way to make up the deficit is to raise fresh capital. In 2010, Petrobras did raise $79 billion in fresh equity but it has been dependent upon debt as its primarily financing in every other year. As a consequence, Petrobras had total debt outstanding of $135 billion at the end of 2014, more than any other oil company in the world.
Step 5 - Destroy value (Mission accomplished)
If you over invest and grow without heeding profitability, while paying dividends you cannot afford to pay and borrowing much more than you should be, you have created the perfect storm for value destruction. In fact, the way Petrobras has been run so defies common sense and first principles in corporate finance, that if I were a conspiracy theorist, I would be almost ready to buy into the notion that this is part of a diabolical plan to destroy the company hatched by evil geniuses somewhere. I have learned through hard experience, though, that you should not attribute to malevolence what can be explained by greed, self-dealing and bad incentive systems.
It is worth noting that none of the numbers in the last section can be attributed to the drop in oil prices. In the most recent twelve month data that you see in these graphs represent the year ending September 30, 2014, and the average oil price during that year exceeded $100/barrel.The government of Brazil, working through the management that they installed at Petrobras, have pulled off the amazing feat of destroying more than $200 billion in value with no help from outside.
A Contrarian Bet?
When a company falls as fast and as far as Petrobras has, it attracts the interests of contrarian investors and the company looks attractive on the surface, at least using some conventional multiples.
Petrobras looks very cheap, at least using equity multiples (PE and Price/Book) but the results are mixed with enterprise value multiples.
All of these multiples are affected by the fact that oil prices have dropped dramatically since the most recent financial statements and that the earnings numbers, in particular, will dive in the coming quarters. Given that Petrobras was already reporting sagging profits, before the oil price drop, I am almost afraid to think of what the numbers will look like at today's oil prices (which are closer to $50)., but I will try anyway. Looking at the annual revenues over time at the company and relating them to the average oil prices each year, here is what I find:
Just as looking at companies that have created significant amounts of value over time is enlightening because of the insights you get into what companies do right, Petrobras should become a case study for the opposite reason. Put in brutally direct terms, if you were given a valuable business and given the perverse objective of destroying it completely and quickly, you should replicate what Petrobras has done in five steps.
Step 1 - Invest first, worry about returns later (perhaps never)
Invest massive amounts of money in new investments, with little heed to returns on these investments, and often with the intent of delivering political payoffs or worse. Between 2009 and 2014, Petrobras stepped up its capital expenditures and exploration costs to more than 35% of revenues, well above the 15-20% invested by other integrated oil companies, while seeing its return on capital drop to 5% (even as oil prices stayed at $100+/barrel for the bulk of the period).
Step 2 - Grow, baby, grow, and profitability be damned
Petrobras has grown its revenues from $17.4 billion in 1997 to $135.8 billion in 2014 and displaced Exxon Mobil as the largest global oil producer in the third quarter of 2014, while letting profit margins drop dramatically. The government contributes to this dysfunctional growth by putting pressure on the company to sell gasoline at subsidized prices to Brazilian car owners.
Step 3 - Pay dividends like a regulated utility (even though you are not)
Petrobras has a history of paying large dividends, partly because it had the cash flows to pay those dividends in the 1990s and partly to supports it voting share structure. The preferred (non-voting) shares that the company has used to raise capital, without giving up control, come with dividend payout requirements that are onerous, if you have growth ambitions.
Step 4 - Borrow money to cover the cash deficit
If you want to eat your cake (by investing large amounts to generate growth) and have it too (while paying large dividends), the only way to make up the deficit is to raise fresh capital. In 2010, Petrobras did raise $79 billion in fresh equity but it has been dependent upon debt as its primarily financing in every other year. As a consequence, Petrobras had total debt outstanding of $135 billion at the end of 2014, more than any other oil company in the world.
Step 5 - Destroy value (Mission accomplished)
If you over invest and grow without heeding profitability, while paying dividends you cannot afford to pay and borrowing much more than you should be, you have created the perfect storm for value destruction. In fact, the way Petrobras has been run so defies common sense and first principles in corporate finance, that if I were a conspiracy theorist, I would be almost ready to buy into the notion that this is part of a diabolical plan to destroy the company hatched by evil geniuses somewhere. I have learned through hard experience, though, that you should not attribute to malevolence what can be explained by greed, self-dealing and bad incentive systems.
A Contrarian Bet?
When a company falls as fast and as far as Petrobras has, it attracts the interests of contrarian investors and the company looks attractive on the surface, at least using some conventional multiples.
All of these multiples are affected by the fact that oil prices have dropped dramatically since the most recent financial statements and that the earnings numbers, in particular, will dive in the coming quarters. Given that Petrobras was already reporting sagging profits, before the oil price drop, I am almost afraid to think of what the numbers will look like at today's oil prices (which are closer to $50)., but I will try anyway. Looking at the annual revenues over time at the company and relating them to the average oil prices each year, here is what I find:
Revenues at Petrobras = -4,619 million + 1276 (Average Oil price during year) R squared = 92%
Thus, if you assume that the current oil price of $51.69 is close to the average for this year, the normalized revenues for Petrobras will be $61.3 billion, a drop off of about 55% from the $135.8 billion revenues in the 12 months ending September 30, 2014.
Revenues at Petrobras = -4,619 million + 1276 (51.69) = $61,337 million or $61.3 billion
If you apply the operating margin of 10.82% that Petrobras reported in the trailing 12 months to these revenues, you arrive at an operating income of $6,638 million, prior to taxes. At that level of earnings, the value that I get for the company is $62.4 billion, well below the $135.1 billion owed by the company, making its equity worth nothing. In the matrix below, I look at the value per share under different combinations of base year income (ranging from $6,638 million at the low to $28.7 billion at the high) and return on invested capital on new investments (again ranging from a low of 2.67%, with income normalized for low oil prices, to 13.36% as the high): |
| Assuming no high growth period, stable growth rate of 2% and cost of capital of 11.17%. Adding a high growth period reduces value in all the return on capital scenarios, except one (average over last 10 years) |
The red numbers represent the dead zone, where the value of the business is less than the debt outstanding and they dominate the table. In spite of the reckless abandon shown by its management, there remain some bright spots, if you are an optimist. The first is that the company is one of the largest oil producers in the world and if oil prices rebound, they will see a jump in revenues. The second is that the exploration and investments over the last decade have given the company the fifth largest proven oil reserves in the world, though the proportion of these reserves that will be viable at today's oil prices is open to question. The third is that if the Brazilian government stops pulling the strings and management stops its self destructive behavior, profit margins and returns will improve. In the most optimistic spin, you can assume that Petrobras will be able to keep its trailing 12-month intact at $135.8 billion, improve its operating margin to the 21.1% that it earned in 2010 and its return on capital to 13.36% (10-year average), while reducing its debt ratio to 43.5% (average over last 5 years). With those assumptions, which border on fantasy, Petrobras would be worth $8.11/share (R$ 22.55/share) well above the current stock price of $3.28/share (R$ 9.12/share). You are welcome to try out different combinations of your assumptions in this spreadsheet and see what you get.
Unsolicited (and perhaps unwelcome) advice for a new CEO
A couple of weeks ago, Ms. Maria das Gracas Foster, Petrobras CEO since February 2012, stepped down, and the Brazilian government announced that it has chosen Mr. Aldemir Bendine, former head of Banco do Brazil, as the next CEO. The market response was almost universally negative, partly because Mr. Bendine does not have any experience in the oil business and partly because there is no trust left in the Brazilian government. I do not know Mr. Bendine and it would be unfair of me to tar him as a government stooge, just because he was appointed by the government. In fact, I am willing to not only cut him some slack but to also provide advice on what he should do in the coming weeks. Here are my suggestions:
- Hire a chief operating officer who knows the oil business and turn over operating responsibilities to him.
- Fire anyone in the top management who has any political connections. That may leave lots of empty offices in Petrobras headquarters, but less damage will be done by no one being in those offices than the current occupants.
- Side with directors for the minority stockholders and push for a more independent, accountable board.
- Refuse to go along with the cap on gasoline prices for Brazilian consumers, a subsidy that has already cost the company $20-$25 billion between 2011 and 2013. With oil prices low, the consumer backlash will be bearable.
- Push openly for a move to one class of shares with equal voting rights. Accompany this action by cutting dividends to zero.
- Clean up the investment process with less auto-pilot exploration, production that is in line with oil prices and less focus on growth, for the sake of growth.
- Start paying down your debt.
What is the worst that can happen to you? If the government is set on a path of self-destruction, you will be fired. If that happens, wear it as a badge of honor, since your reputation will be enhanced and you will emerge looking like a hero. If you go along with the status quo, you will preside over the final destruction of what was Brazil’s crown jewel and face the same fate as your predecessor. Unless the new CEO can come up with a way to remake the company, my guess is that, at least for the next few months, here is the song that will be playing out in the market:
Final Thoughts
There are always lessons to be learned from every calamity and Petrobras qualifies as a calamity. The first is to recognize that there every reason to be skeptical when politicians claim "national interest" and meddle incessantly in public corporations. In most cases, what you have are political interests which may or may not coincide with national interests, where elected politicians and government officials use stockholder money to advance their standing. The second is that those who have labeled "value maximization" as the "dumbest idea" and pushed for stakeholder wealth maximization, a meaningless and misguided objective that only strategists and Davos organizers find attractive, as an alternative, should take a close look at Petrobras as a case study of stakeholder wealth maximization gone amok. In the last five years, Petrobras has enriched countless politicians and politically connected businesses, subsidized Brazilian car owners and provided jobs to tens of thousands of oil workers, leaving stockholders on the outside looking in. Anyone who argues that this is a net good for Brazil has clearly not grasped the damage that has been done to the country in the global market place by this fiasco.
Corruption update: I have been asked by many of you as to why have sidestepped the corruption stories that have been swirling around the company. I did so, not because I want to avoid controversy (which I don't mind at all) but because I thought that at least in this case, being subtle delivers the message about political game playing better than brute force. At Petrobras, I treat corruption as a really bad investment with horrible returns to stockholders, but I believe that with its management structure, the company was destined for trouble, and that the corruption just greased the skids.
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40 comments:
Great post.
As a brazilian living abroad I feel sad about what is happening there.
I wonder one thing on your reflection, during the last year big news on how the government used Petrobras as the nest for a big corruption scheme, going on the 2 digit billions. Have you included that in your analysis but left out of the text so you don't create controversy?
Thank You Mr. Damodaran for your valuable insight.
Is there a risk that the same fate awaits Vale & Lukoil? or was this stunning fall from the heavens because Petrobras was just to close with the Government interest/ deal-making.
Thanks,
Tim
Hi Professor Damodaran,
I really appreciate your thoughtful analysis. Quick question, Im looking at PBR on Bloomberg and seeing a current price of $6.31. AAm I looking at the right ticker?
Hi professor!
Fantastic post! I asked you about this in post "Go where it is darkest: When company, country, currency and commodity risk collide!"!
In here brazil, there is a joke about: what will it reach first to the R$ 5, price of fuel, dollar or petro?? Rsrsrs, actually the price of fuel is R$ 3,60 and dollar R$ 2,84.
I agree with you everything. I would like if Mr. Aldemir Bendine noted your post.
One point important is the viability of new reserves in deep waters due oil price drop. So, there is a economy belt to cause, like ports, petrochemical complex, shipyard, etc. Include, there are big companies responsibles around 75% (my number)for buildings, like roads, trains, PPP, concessions, airports, etc, and they are wrapped with corruption between big companies and petrobras. Can we be next crisis in Brazil?
I have a suggestion to next post. With your post "The Dance of the Disrupted: Observations from the front lines", please, show a company follow up "The Dance of the Disrupted: The Five Stages". What do you think?
Thank you for your posts, I really enjoy them.
Best regards,
Ayron Medeiros
"Is there a risk that the same fate awaits Vale & Lukoil?"
LUKoil has largely avoided the "5 steps of Destruction Roadmap"
They have generated Free Cash Flow in 10 of the past 10 years (they don't over-invest at the expense of returns)
They have one of the lowest Debt/Equity ratios of any O&G company (they don't use debt to finance growth)
They generate fairly attractive returns on equity - double digits nearly every year (profitability is not damned)
Dear Professor,
Thank you for if your posts and website. I'm not sure I understand the comment about current pricing of 3.28. Per previous question, pbr seems to be trading well above 6
Anonymous 2,
On the pricing of Petrobras, you are looking at the ADR, which is denominated in different units than the ordinary shares listed in the Bovespa. There are two local listing shares per ADR. So, if you are using the ADR, multiply the value per share that you get in my spreadsheet by two and you should be all set to go.
Anonymous 1,
Could Vale face the same fate? I guess so. I think that what saved Vale was they were never as cash-rich as Petrobras and did not get as much press attention. Cash and media focus are like catnip for politicians. If I were Vale's managers, I would move the whole company to the a small town somewhere on the Brazilian coast and leave no forwarding address, hoping that Brazilia never finds me. Vale is at the mercy of commodity prices, like Petrobras, but it did not borrow as much or invest like a drunken sailor.
Lukoil is different. It is not a Russian company though it cannot get on the wrong side of the Russian government. The analog to Petrobras in Russia would be Rosneft, where the Russian government does exactly what the Brazilian government does: meddle incessantly with a hefty dose of corruption/side payments along the way.
I think more interesting is Elecrobras. Ticker EBR.B. They own about 35% of Brazil's electrical generation and about 85% of the transmission. Much of the electrical generation is from hydropower, which has been hit by a multi-year drought of epic proportions. The new government also has imposed price cuts on the sale of electricity. The government imposed price cuts combined with the drought have resulted in loss of profits and rolling blackouts. The government also owns a large portion of the company in a similar manner to Petrobras. Skewed incentives and corruption abound.
How this is interesting is that the price to book value is incredibly low. You essentially buy electric dams at pennies on the dollar. If the drought in Brazil ever ends or even just gets less bad and the government quits playing politics with electric prices this company could be a serious cash powerhouse.
Great post! Thank you.
Professor, it's a great post.
But I think that the challenge that Petrobras faces is much greater than that.
As you pointed out, Brazilian gas and diesel prices to retail customers are regulated.
During the last 4-5 years Petrobras lost duzens of USD BILIONS by selling subsdied fuel (it exports the crude oil and imports the fuel).
Now that we've a fuel that is 50% or so higher than the "unregulated market", it would be their chance to compensate that account and get some revenue back. But, as you can imagine, gas prices are a major item in the inflation basket. Inflation in Brasil is over the upper limit of the target -> 4,5% with +- 2% limit - we're now over 6,5%. I don't know how much longer they can hold on these prices, specially with an economy that will not grow in 2015 (projections -0,5% YoY GDP)
Meanwhile, most of the CAPEX estimated by Petrobras will be invested in the "Pre-Salt" Area, very deep waters, which have a higher extraction costs - some say between USD 30-50 per barrel.
So, in the end, we may have a company that will lower gas prices, reducing their revenues and profits (to control inflation and to be in line with unregulated prices), while most of the reserves being extracted will have very low margins, at least during this new "low oil prices" world.
And that's not all - you have to face all that while you have the title of "Company with Most Debt IN THE WORLD" - (not just in oil market) with a HUGE investment plan for the next 5 years. You'll need a nice balance sheet - and what we have? Troubles to release their 3Q14 finantial statements, due to corruption.
it's a very though call...and i'd never invest in petrobras.
Well...that's a lie. My price is R$ 5 per share...
the only thing that is helping is that with the depreciation of the BRL, the company is getting cheaper and cheaper if you think in USD.
Damodaran,
Would love to read a post on your views of the Eike Batista fiasco.
Like many people who follow you, I am really looking forward to your revised VALE valuation....
Prof,
Another great post. Can it happen in India also? Because we are seeing State company sale and Dividend milking from Public sector companies though few are debt ridden. Please throw some light.
Could this be a good opportunity investment for its bonds? I mean, the are cheap, and discounting a high probability of default.
Taking into account that a default is unlikely due to political reasons (I know, I am suposing too many things), maybe it seems reasonable to buy bonds or "sell the option on the assets".
Great post professor!
But, although I believe in Warren Buffett’s approach of not investing in companies we don’t understand, I think now is a correct time to buy, believing in company’s turn over.
The corruption in Petrobras is not a new issue. But I believe that now the government is making a great effort to change it.
So my investment thesis is based on Corruption not on valuation.
Regards
Anthony Wally
My thoughts on Elke Battista: Hubris + Greed = Disaster.
Hi Prof.
are there more names share the same "darkest.." that vale and lukoy have
Ecopetrol (EC US) - A replay of this is in the making.....
Which other company follows your “A Roadmap for Value Destruction” script yet appears infallible and has been given an endless runway to succeed whereby it pretty much finance its payroll with stock with impunity.
Amazon:AMZN
Step 1 - Invest first, worry about returns later (perhaps never).
CHECK
Step 2 - Grow, baby, grow, and profitability be damned.
CHECK
Step 3 - Pay dividends like a regulated utility (even though you are not).
Not quite, but had done sizeable stock buybacks in the recent past.
Step 4 - Borrow money to cover the cash deficit
CHECK
Step 5 - Destroy value (Mission accomplished)
Work in progress, but the sugar daddy market (like the Brazilian govt) sure seems to be cutting it a lot of slack.
Professor Damodaran,
Thanks for the very informative article. A couple of comments for your consideration:
1. The $72.8 billion raised in 2010 was a capital call made the the controlling shareholder (the government), where it paid its part in oil reserves 5 miles deep below the ocean floor, while requiring all other shareholders to put up cash. So, it was less than about raising capital and more about diluting minority shareholders. If another capitalist tried to do that, he'd end up in jail.
2. Be careful not to disseminate misleading propaganda for this (pitiful) government. It is trying to make a big fanfare of the fact that Petrobras is currently the world's largest producer, but omitting the fact that ExxonMobil has about 4 times its revenues and 9 times its market cap. And, critically, it omits that several of the largest producers are not listed companies. Saudi Aramco, to name one, produces about 3.5-4 times its volume.
3. Finally, you cannot tar Mr Bendine as a government stooge, but those of us who know him can. His sole qualification for this position is his unqualified obedience to the President and her political court. Her labors of value-destruction are not done yet and your advice will be lost on him...
Thanks again,
Ricardo
Thanks for this good article. I read your comment about value maximization vs. stakeholder wealth maximization and I'm now very curious about your thoughts on that subject. Maybe it's a good subject for an article.
I totally see your point that stakeholder wealth maximization can be used as a perfect excuse to steal, gain political power, etc, as it happened with Petrobas. However, there are also positive examples of companies who have applied it in a good way. When it comes to value maximization strategies, you can also find both positive and negative examples.
From a philosophical point of view, I often struggle to understand why a shareholder who might hold shares only for a couple of days should be given priority over an employee who has been in the company for 10 years (as in the cases when companies fire 10% of the employees because net income declined by 15%). But I'm an investor too and I like it when companies align with my interest and take decisions that maximize my value. It's a pretty complicated subject I would say.
Are there any articles on this subject that you recommend?
Thanks,
Jordi
Great post. Very similar to India's ONGC.
http://valueanalyst.blogspot.in/2013/11/ongc-is-not-fair-game.html
Only good news is that ONGC is not debt heavy.
What are your thoughts on ONGC, especially at today's prices?
Hi
Petrobras' tickers in the Brazilian market are PETR4 and PETR3..
Hi Prof Damodaran,
Can your next post include Bollore (BOL FP) a French holding comapany. Which according to Carson Block from Muddy Water the company's opacity created a buying opportunity since BOL effectively owns a significant portion of itself that the market does seem to realize.
Thanks,
Tim
Interesting post, but you missed the point as it relates to how low (international) oil prices impact the company. Petrobras makes most of its money by selling refined products domestically at fixed prices. It is not able to produce enough refined product to satiate demand, so it has had to import oil (at international prices). This was bad for Petrobras over the past 4 years, since domestic prices were lower than international prices, and it causes huge losses. This situation has now reversed, as mentioned in a previous post. This is a major positive development for the company. If oil prices stay low and the real does not depreciate too much against the dollar, the company will get a HUGE boost to the cash it is generating.
Hi Professor,
Great post, explains very well everything Petrobras / PT made wrong on the past years. However, I will daresay your valuation methodology is not very appropriate to this case – the whole R square thing / oil price adjustment to net revenues times operating margin is too simplistic. It would have worked perfectly for Exxon, but not for Petrobras. Oddly, the company loses money when oil prices go up, as they do not pass through “external volatility” into local markets, an euphemism for selling fuel at a loss. So exploration and production (lifting cost around USD35/barrel) makes money. But then Petrobras imports lighter oil to refine locally and then... well, they sell it at a loss. A big loss. With oil at say USD60/barrel E&P will definitely make less money, but refining will stop losing / start making some. I believe that the net effect could be positive. However, to make things even more uncertain, one would have to guess the level of the Brazilian Real – if it devalues enough the company will start losing even more money, as, again, oil imports are USD-based but their sales are BRL-based. Finally, as you always point out, one needs to think of the end-game / story, not only the numbers. How much more can this company suffer? More debt will mean losing the investment grade rating not only for the company but for the country, as rating agencies will start factoring in the implicit Government support. The PT is self-serving and corrupt, but I do not believe that the Brazilian people will accept becoming Venezuela. So if they want to keep in power, they better let Petrobras increase prices gradually, reduce capital expenditures and diminish negative free cash flows. The cost of not doing so is political suicide. How's that for a story + numbers? I am long.
ps. big risk of very dilutive capital increase. You may want to add some puts with your long position. Better lose a bit of the capital at start and sleep cozy. After all value can triple if PBR improves just a bit.
Ps 2. Long Lukoil as well. Read The Economist of this week on Putin and think twice.
Prof. Donadaran,
Congratulations on your article.
Only a small contribution for your critical analysis on Petrobras. The company had its share listed at the Bovespa in the 60's, both common and preferred, with most of the liquidity concentrated in the latter and common shares traded at a huge discount to preferred until the mid 90's.
This picture changed when ADR's negotiations started at NYSE in 1998 with foreign investor concentrating their purchases in common shares most likely for two reasons: tradition by foreign investor to buy common shares, and a bet on an unlikely privatization of the company.
Also, worthy citing the change in the regulatory framework that took place after the pre-salt discovery announcement in 2007, in my opinion the major responsible for putting the company in this shameful situation today.
If Petrobras remained under the concession system, not obliged to enter in every single sharing pre-salt auction with a minimum 30% participation, if the company was not submitted to ideological government industrial policies of national content and development, and finally if investment decisions were not influenced by personal whims of former President Lula to sustain regional political alliances, this article would never be written.
Thank you,
Ricardo Dunshee de Abranches
Hello Doc.,
A wonderful article. Enjoyed reading it. I think the Title should have been "The Rise and Fall of Petrobras", though!!!!!
Full of Correct facts and figures. My Kudos.
Not sure your revenue drop "math" makes sense, cause Brazilian gasoline, diesel, Jetfuel, etc do NOT follows oil market prices.
On the contrary, the gasoline price is in fact more expensive now in Brazil because the government raised taxes over it.
Therefore, the revenue depends on the domestic market and the import/export balance. I believe Petrobras is a net Importer. Therefore, the oil drop is healthy for Petrobras in the short term.
I am Brazilian, I do not know English and yes, I am using google translator, I hope you understand me.
I know that the focus of the article was the share value. Since I have no stomach to invest in stocks, I will not defend the purchase or sale of shares.
You cursed interventionism in Petrobras. Interventionism does exist, everyone knows. But what you do not know is that this intervention ensured that Petrobras invested in recent years in thermoelectric power plants, wind plants, photovoltaic plants and small hydroelectric power plants, generating an average of 4.7 GW for the eletric National Interconnected System (SIN) in 2014, enough to generate power for 15 million people
What I mean is: without this federal government intervention at Petrobras, there would be not enough power generation in Brazil today, as we face a long water crisis since 2013. We brazilians would be today through good part of our days without electricity.
What I can say is that the company's debt is very high, but not out of control, Graça Fostes did a good job, repaired many things that were wrong in the company. She had been an employee of Petrobras for many years. She was not involved in politics. She has great expertise in oil and gas and has a good reputation. She resigned under pressure from the press, who linked her image to corruption scandals without presenting any evidence whatsoever.
Great to see here in this respectable blog so many Brazilians spending their English speaking. It’s even better seeing so many Brazilians desiring Petrobras bankruptcy and I can assured that these "Brazilians" will be surprise in the future.
Damodaran, I respect you, but as a Brazilian citizen I must inform you, dear foreigner, the article is yours, but O Petróleo é Nosso (google it).
Thank you for this useful analysis. It is refreshing to see such a well-researched, well-structured article when many other writers are satisfied to stay on the surface and repeat what has been said before.
Since you published this text, Moody's has downgraded Petrobras, which is likely to make the comeback an even more difficult task.
I would like to mention a few other aspects that were not touched upon in your article. (Perhaps you decided that these were mere details that wouldn't add anything to the overall picture.)
The failure to publish an audited balance for Q3 of 2014 has made it difficult/impossible for Petrobras to raise cash on the international markets. If the financial reports are not published before the end of the deadline, the holders of some bonds have the right to demand repayment in full at once.
Legal procedings agains Petrobras, its suppliers, the operators of the money laundering scheme, and the political benefactors will drag on for some time to come. That means that Investment plans will remain uncertain for some time to come.
There is a possibility that (some of) the construction companies involved in the corruption scandal might be excluded from any future contracts from government agencies - at least for some time. These companies are also involved in other major ongoing projects - the refurbishment of São Paulo's main airport, Guarulhos, and the construction of the facilities for the 2016 Olympic Games, to name but two. There is a risk of delays in these projects, with blocked assets and jailed executives. All this is likely to worsen the already difficult economic situation in Brazil, and has already produced predictions that Brazil itself might be downgraded.
Some of these things are at present only fears or speculations, but they are not completely unfounded.
Professor, the points about growth with no return on capital seems to fit Amazon yet its stock flies.
Thanks - as always, good reading and learnings!
With VALE now trading below $6, I went back to the VALE valuation spreadsheet that you had posted back in Nov'14 (http://www.stern.nyu.edu/~adamodar/pc/blog/ValeNov2014.xls). With the benefit of additional quarterly results and sentiments on China/commodity growth (or lack thereof) - had a few follow-up questions as I update the model:
1. When calculating the operating income for the valuation model - is it fair to peel out the "unusual expenses". These seem to occur quite regularly for VALE ($10.3B in the last 3 years)? I noticed that you had 'normalized' these operating expenses in your original model by removing these items/amounts categorized as "unusual expenses". However, would be great to get some commentary on the pros/cons of doing this since it has a material impact on the valuation.
2. With the actual 2014 operating income results now plugged in (not normalized) at $7.1B and basing the valuation on 20% below LTM; the valuation is $5.22 (- which is considerably closer to the current market price - a coincidence?). The question though is what do you see as the most material metrics to track over the next couple of quarters given the wide range of valuation forecasts ?
-Thanks
Gaurav
I opted to invest in EWZ and ERUS rather than individual companies and "investors venture where it is darkest, the nether regions of the corporate world where country risk, commodity risk and company risk all collide to create investing quicksand" was definitely my mantra.
I like NOCs (like PEMEX, PBR.A) where those governments are now FORCED to treat shareholders better and be more efficient or face ruin. Just nibbling on those companies. I'd think industrial automation companies and competitive contractors would make interesting investments.
Just to add on my previous comment that the valuation methodology did not seem appropriate: oil prices fell 50%, the BRL devalued and STILL Petrobras operating income and cash flow from operations improved. That is because PBR is the only company on the planet to have (largely) BRL revenues for its oil derivatives and USD costs for its imports. The refining bit of PBR stopped losing money: a USD3.2 billion profit versus USD3.1 billion LOSS last quarter. Consolidated operating profit went from USD3.2 billion last quarter to USD4.7 billion in 1Q15.
This gets back to my point that to correctly value a company like PBR you have to re-engineer the most relevant operations (E&P and Refining) in you Excel model. Averaging past profits will likely send you in the wrong direction.
Professor - I believe you may be making the same mistake on Vale and arguably Lukoil as well. I would separate tangible value - the liquidation of existing reserves and assets - from "nice to have" value... I would never assume a perpetuity for a fossil fuel/mining company! There is no growth other than hope to find more oil/ore in the ground in such case! I would not pay much for that!
Thanks Prof for the insightful article.
I read the linked article where Salesforce CEO says stockholder maximization as dumbest idea and i also listened to your view that stockholder maximization as prime goal through the example that making all 6 people happy in your home is impossible. However, i fail to understand why successful CEOs (Jack Welch, Paul Polman) dont agree with you?
Since this post was published on Feb 2015, PBR stock jumped to 9.1 from 6.23 on Feb as oil prices climbed. Now the guru is lecturing in Brazil about PBR, so much for a guru, heh?
And the Brazilian government only contributed to worsening the situation.
Mr Damodaran,
Would you be willing to revisit Petrobras as you did with Vale?
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