The Value of a Controlling Interest in an Expropriated Oil & Gas Company: YPF SA

I. Abstract

This technical paper presents an example of the use of different valuation methodologies when applied to the question of the value of the controlling interest that the Spanish firm Repsol held in the integrated oil & gas corporation YPF Sociedad Anonima until its expropriation by the Argentine national government in May 2012. This problem involves two of the signal problems in valuation: the presence of asymmetric risk and real options.

Both traditional and novel methods are used in this analysis, including: standard discounted cash flow and market-multiple models; along with the novel recursive (“value functional”) method. A benchmark of market prices around the time of the expropriation is used to evaluate the strength of the valuation methodologies. To make the comparison rigorous, wherever possible the same underlying assumptions and data are used in all methods, with no subjective adjustments.

The following results emerge from this analysis:

1. Traditional valuation methods often produce estimates that differ substantially from market prices when real options or asymmetric risks are present. The magnitude of these estimation errors, as demonstrated here, can easily exceed 50% of the market value of a company.
2. The value functional method can natively incorporate real options and asymmetric risk. Furthermore, the method can produce value estimates that are relatively close to market prices even when real options and asymmetric risks are present.
3. A recursive valuation supports the claim made by Repsol that the value of their expropriated shares in YPF SA was at least $10.5 billion. Traditional methods, unadjusted, produce estimates significantly below that figure.

II. The Valuation Methodology Question

KEY ISSUES IN VALUATION OF OIL & GAS COMPANIES

For comparison purposes, we also report contemporary analysts’ reports on YPF stock, and calculations of contractual damages based on market prices and earnings of the company in the initial months of 2012. These market-based values are then used as the benchmark against which we compare the estimates from traditional and recursive methods.

The subject company in this case presents two recurring issues in valuation: the presence of asymmetric risks, and real options. These are especially prevalent in industries such as oil & gas, pharmaceuticals, technology, entertainment, and natural resources, and are nearly always present in entrepreneurial and start-up firms.

• The potential for big swings in oil prices, technological shifts in the costs of exploiting shale reserves, and the unknowable amount of actual, exploitable shale oil available to YPF combined to produce a rich mixture of asymmetric risks for its shareholders.

The existence of these risks, along with the availability of contemporaneous data, present an excellent factual basis for a methodological comparison among traditional and recursive methods of valuation.

OUTLINE OF TECHNICAL PAPER

The paper is organized as follows:

• The challenges real options and asymmetric risk pose to traditional valuation methodologies is discussed in “Problems with Traditional Valuation Methodologies”.
• The subject company YPF SA is described.
• The relevant valuation models, including both traditional and the novel recursive method, are described.
• The common data used for all models is described.
• The results are summarized.
• Conclusions regarding the methodology and valuation question are stated.

In addition, we include the following discussions:

• Limitations

III. Information on YPF SA

YPF SA is an integrated oil & gas company with extensive reserves in Argentina. It had formerly been a state-owned company, but was privatized in the early 1990’s. Its largest shareholder (until the expropriation) had been Repsol, a Spanish energy company. A 51% stake Repsol held in YPF SA was expropriated by the Argentine national government under a law passed in April 2012.

YPF had a history of profitability, and of paying a large share of its earnings out to shareholders in the form of a dividend. However, the Argentine government began to pressure YPF in the years leading up to the expropriation of Repsol’s shares to use the cash earnings of the company to aggressively exploit the country’s shale oil reserves, rather than pay large dividends.

YPF SA has common stock traded on the Buenos Aires stock exchange, and American Depository Receipts (ADRs) traded on the New York Stock Exchange. Extensive information is available about YPF SA from the following sources, which were used extensively in this analysis:

• Reports and analyses from various financial sources.

DATA

The following data and assumptions were used in all methods.

IV. Valuation Methodology

PROBLEMS WITH TRADITIONAL VALUATION METHODOLOGIES

Both asymmetric risks and real options are known to render invalid the basic assumptions underlying traditional discounted cash flow (“DCF”) valuation methods.

• Traditional DCF models rely on the assumption that the underlying distribution of risks is at least approximated by a smooth, bell-shaped curve of potential outcomes.
• Traditional DCF models evaluate one scenario of future economic conditions and management decisions.

THE RECURSIVE METHOD

A novel alternative to traditional DCF analysis is known as a “recursive” or “value functional” method. The recursive method involves casting the objective of the manager or investor as the optimization of the value of the company or investment, across all available actions.

BENEFITS OF THE RECURSIVE METHOD

The recursive method has significant advantages for problems of the type presented here. In particular, the recursive or value functional method natively handles both asymmetric risks and real options, and it produces a value estimate for each set of conditions (or “states”), as well as a value-maximizing policy.

RESULTS

PRESENTATION OF UNADJUSTED RESULTS

Using the same assumptions and base data, we estimate the value of Repsol’s YPF shares using multiple methods. We then compare them to see which methods come closer to the actual market price.

The benchmark for our valuation estimates, then is an amount approximately between $9 billion and $11 billion, as indicated by market prices.

The naive (unadjusted) method substantially underestimates the value of the company as of May 2012, suggesting an intrinsic value of approximately $4.7 billion.

VI. Conclusions

The results demonstrate that the theoretical superiority of the recursive method can result in practical improvements in valuation, when compared with other methods. Furthermore, these results support the claim that Repsol’s shares were worth, at least as an order-of-magnitude estimate, around $10 billion.