On Monday, Phillips 66 (NYSE:PSX) announced that it was selling one of its units, Phillips Specialty Products, to Warren Buffett's Berkshire Hathaway (NYSE:BRK-B) in a deal currently valued at $1.42 billion. But, what exactly does Buffett see in this unit and what kind of value does he likely expect it to bring? Or, is it possible that his investment is a way to buy up the good part of Phillips and divest Berkshire of most of the enterprise after the stock's run-up?
Terms of the deal
According to Phillips 66, the deal will be conducted in shares of its own stock as opposed to cash in the way that most of Buffett's deals are done. The transaction will consist of Berkshire Hathaway exchanging around 19 million shares of the 27.1 million shares it owns of the company (or 70.1% of its stake) for the unit. Unfortunately, details are scarce on the size and profitability of the unit, but there is enough information out there to get a fair idea of why Buffett is interested in conducting the deal and why he is going about it in the manner he is.
In the release, Phillips announced that the unit would have cash on hand of roughly $450 million, which makes Berkshire's net cost somewhere around $970 million. Though this sounds big to investors like you and I, the deal is far smaller than the company's $3.6 billion acquisition of ExxonMobil (NYSE:XOM) shares earlier this year.
What the segment means to Berkshire and Phillips
In lieu of information that is specific to the unit, the best information to go off of is the financial data in the company's specific segment: the company's marketing and specialties segment. This segment focuses on the resale of refined petroleum products, primarily throughout the United States and Europe, but also manufactures specialty products like lubricants and improvers. It is the second part that the unit being acquired by Berkshire is centered on.
During the first three quarters this year, revenue of Phillips' marketing and specialties segment came in at $86.9 billion, 0.4% lower than what it brought in during the same quarter last year. Despite the reduction in revenue, the segment saw its profitability increase as fuel margins both in the United States and abroad expanded. The margins on each barrel sold were so much larger in the quarters this year compared to last year that the segment's net income rose 124.9% from $338 million to $760 million.
While these results are impressive, there is some downside. For the first nine months of this year, the specialties portion of the segment (the side that likely represents most, if not all, of Berkshire's purchase) saw its net income fall 13.3% from $158 million to $137 million. The larger and more lucrative portion of the segment, its marketing and other category, saw its net income rise by 246.1% from $180 million to $623 million. While Berkshire's new position will still likely carry with it a great deal of value, the downside could prove disadvantageous should it continue.
Buffett's foray into energy
For some time, Buffett has had a bit of a love interest with energy companies. Currently, Berkshire owns MidAmerican Energy Holdings, a large utility conglomerate. Additionally, leading into the 2007-2009 financial crisis, Berkshire acquired a large stake in ConocoPhillips, one of the largest energy companies in the United States. Despite being burned from the ConocoPhillips deal when oil prices plunged, Berkshire bought a substantial stake in ExxonMobil, the largest energy company in the United States.
Over the past four years, revenue at ExxonMobil rose 55.3% from $310.6 billion to $482.3 billion. Coming out of the financial crisis, the firm has seen its bottom line improve even more. Between 2009 and 2012, Exxon's net income jumped 32.8% from $19.3 billion to $44.9 billion. This, combined with the fact that shares are trading at 13 times earnings and 15.7% above their book value (by adding back treasury shares), and it's hard not to like what the company has to offer.
Phillips 66 has offered Berkshire a similar value proposition. Over the past four years, revenue at the company has jumped 60.5% from $113.95 billion to $182.92 billion. Meanwhile its net income has risen a jaw-dropping 766.4% from $476 million to $4.12 billion, all while still trading at 13 times earnings. However, with the company's stock trading near its 52-week high and at nearly 2 times book value, it isn't exactly the cheapest company on the market.
Moving forward, it will be interesting to see what kind of value Phillips 66's unit will bring to Berkshire Hathaway. Right now, all we can do is guess, but the fact that the unit will be under the control of the CEO of Lubrizol, Berkshire's chemicals company, seems to indicate what Buffett has in mind. By reducing his shares in a relatively expensive holding, Buffett is transferring what he deems to be a very profitable part of that business into an existing entity that can more effectively leverage its knowledge and resources to drive profit. Whether this actually happens remains to be seen, but the writing on the wall is fairly clear from here.
Daniel Jones has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.