The Rising Influence of Rising Affluence

[DewDiligence]

The Case for (Not) Owning Petrobras

If PBR were a fully private company, it would be a must-own stock for any serious Natural Resources investor. However, the large government stake, the multi-tier capital structure, and Brazil’s growing nationalistic sentiment make a dangerous combination for minority investors, IMO. The upcoming presidential election, in which one of the leading candidates is a former Marxist guerrilla, also gives me some pause (#msg-51011758).

The history of Petrobras strikes as a subtle con game. In the first step, the company was partially “privatized” with assurances that it would be run for the benefit of shareholders rather than politicians; however, the government retained an equity stake via a special share class that enjoys veto rights on matters deemed to affect a murkily defined “national interest.” Foreign investors happily brushed aside their minority-ownership status and bought into the IPO to get in on what was perceived as a ground-floor opportunity, and they were rewarded in spades when PBR discovered massive amounts of oil in the deepwater Atlantic.

Now, the government of Brazil is effectively telling minority shareholders, “Thank you very much for the use of your capital, which allowed us to turn Brazil into one the world’s premiere oil plays. We’ll take over now!”

I can see this story ending badly for minority shareholders. The more money PBR makes, the greater the temptation for the government to vote itself an ever bigger slice of the profit pie, and there are a thousand legal ways in which they could accomplish this.

Despite PBR’s enviable asset base, I would rather own the shares of such “boring” Big Oil companies as XOM and CVX. For a name with more excitement and upside, I like HES, which has become dirt cheap in response to the Deepwater Horizon story even though it is only marginally affected by the deepwater ban in the GoM (see the table in #msg-50952320).

Then there’s CLB, which is my favorite “oil company.” I use quotation marks because CLB is not a true Natural Resources name, but rather a technology company that generates enormous amounts of cash from minuscule amounts of physical capital. If you looked at CLB’s financial statements without knowing what business the company was in, you’d probably think it was a smaller version of MSFT or GOOG.

Well, that may be more information than you were looking for, but your comment about PBR’s colossal market cap was a handy segue for me to launch into an exposition on a subject I really don’t know that much about. Regards, Dew