Is BP headed for Bankruptcy?

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How low will BP stock go? Today’s guess: All the way to zero. Already, the oil spill in the gulf has caused BP shares to drop to $30 from $60. That’s a loss in total market value of $90 billion. Earlier on this blog, I sided with the camp that thought BP might be a buy, because its stock had fallen so far and another oil company might be interested in picking up its assets on the cheap. Now the conventional wisdom seems to be shifting. This from Mr. Too Big:

The idea that BP might one day file for bankruptcy, particularly as part of a merger that would enable it to cordon off its liabilities from the spill, is starting to percolate on Wall Street. Bankers and lawyers are already sizing up potential deals (and counting their potential fees).

Given the plunge in BP’s share price — the company has lost more than a third of its value since Deepwater Horizon blew — some bankers and analysts say BP is starting to look like takeover bait. The question is, who would buy BP, given its enormous potential liabilities?

Shell and Exxon Mobil are both said to be licking their chops. And already, flinty legal minds are dreaming up scenarios in which BP would file a prepackaged bankruptcy and separate the costs of the cleanup — and potentially billions of dollars in legal claims — into a separate corporate entity.

The question at issue is how expensive the cost of the clean-up and BP’s other liabilities will be. Matt Simmons, an oil industry investment banker, tells Time sister publication Fortune that the cost of the clean up will overwhelm BP. Here’s what Simon had to say:

They have about a month before they declare Chapter 11. They’re going to run out of cash from lawsuits, cleanup and other expenses. One really smart thing that Obama did was about three weeks ago he forced BP CEO Tony Hayward to put in writing that BP would pay for every dollar of the cleanup. But there isn’t enough money in the world to clean up the Gulf of Mexico. Once BP realizes the extent of this my guess is that they’ll panic and go into Chapter 11.

I don’t buy the solution that BP could solve its problems by spinning off its gulf coast operations and shielding the larger company from liability. You see this solution always proposed for troubled financial companies and it never works. The so-called Bad Bank solution always fails because if you were to spin-off the “Bad Bank” it would immediately collapse. And it’s creditors would immediately turn after the “Good Bank,” which then would be the bad bank again.

Some back of the envelope math seems to suggest that BP has a capital cushion to withstand the cost of the spill. But the question is does it have the cash on hand to pay for the clean up and still stay current on its loans and keep the rest of its business going. Bankruptcy afterall is not a capital problem its a liquidity problem. Just ask the banks.

BP has reportedly already spent $1 billion on the oil spill, but I would bet that very little of that is clean-up so far. Much of that is probably the cost of the rig and trying to stop the leak. Drilling the two relief wells can’t be cheap. At the end of 2009, BP had a book value (the total of its assets minus liabilities) of $102 billion. But very little of that was cash, just $8 billion (now possibly $7 billion). What’s more, $20 billion of BP’s book value was made up of goodwill and intangible assets, accounting terms in part meant to signify the value of your brand. We can all probably agree that BP’s goodwill now equals close to zero. Whether its stock will follow we will soon see.