British Petroleum Company, Ltd.
(1987 Stock Offering)
| | | | | | | | | | | | | | | |
Formed in 1909, British Petroleum (“BP”) was the world’s seventh largest industrial company and the third largest oil company based on 1986 sales figures. As a part of its decentralization plan which prepares for the privatization of the nationalized industries, the British Government initiated a sale of BP’s stock in March 1987. Later on BP announced an offering of new stock in conjunction with the government sale in July 1987. Underwriting agreement was made between BP and both the domestic and international underwriters on 15 Oct 1987.
The offering date was set for 30 Oct 1987. The price for both the fixed-price offer and the international offer was set at ￡3.30 payable in three installments. While the first installment of ￡1.20 was due immediately upon sale, the second and third installment of ￡1.05 were due on 30 Aug 1988 and 27 April 1989 respectively.
Right after the underwriting agreement was made, the stock market suffered its largest decline in history. The underwriters of the BP issue faced substantial losses as a result of the drop in BP price. Refusing to rescind the deal, the British government announced on 29 Oct 1987 that the offering would proceed as planned, and the Bank of England would offer a repurchase plan for the underwriters. The bank would buy for ￡0.7 any and all partly paid BP shares that would begin trading the following day. Those who sold their shares to the bank would then be relieved of the second and third installments. The offer to repurchase shares would expire on 6 Jan 1988.
With the drop of BP’s stock value and the Bank of England’s offer of the repurchase plan, the objectives of this case study is to 1) Evaluate from the point of view of the U.S. underwriters the value of the repurchase plan, so as to help decide if they should sell their partly paid BP stock to the Bank of England instead of holding on it to sell it to the individual investors after the offering date; 2) To compare the value for the repurchase plan with the total change in equity value of the U.S. underwriters, so as to have an extra reference on the value of the repurchase plan.
■ The Repurchase Plan as a Put Option
According to the case, anyone who owned partly paid BP shares could sell them at any time to the Bank of England for £0.7 regardless of the then prevailing market price. We have concluded that this offers the equivalent of the Bank of England writing a put option with the strike price of £0.7 plus the present value of the remaining two installments of the price of the BP shares. To be more specific, since the option could be exercised anytime during the life of the offer, it should be treated as an American option.
■ Methodology - The Black-Scholes Model
After the identification of the repurchase plan as a put option, it comes to the vital part of the case study—valuation of the option. As stated earlier, the repurchase offer resembles an American put option which means the Binomial model would be more appropriate for the calculation of the option price. We are aware that the a major limitation with the Black-Scholes model is its incompetence in pricing an American option due to the fact that it only calculates the option price at expiration. However, the statistics given are not sufficient enough for us to precisely compute the price of an American option. Furthermore, the main objective of this report...
Please join StudyMode to read the full document