Source: Phillips 66.
Phillips 66 (PSX -0.47%) recently held its second analyst day since becoming an independent public company. It went through all of its growth plans and its financial targets, all of which show analysts and investors how the company plans to create value over the long term. One way, however, really stood out to me and that's how it plans to use a special IRS tax loophole that's available to its newly created Phillips 66 Partners (PSXP) to unlock additional value within its midstream segment.
The building blocks of value creation
Phillips 66 took Phillips 66 Partners public in July 2013. It owns 73% of the limited partner units as well as a 2% general partner interest. At the time of the initial public offering, Phillips 66 Partners owned three midstream systems. The plan is to slowly grow the partnership through a combination of development projects and acquisitions.
The main acquisition growth driver is drop-down transactions between the partnership and Philips 66. The first of these drop-down transactions occurred earlier this year when Phillips 66 sold $700 million in assets to Phillips 66 Partners. That deal enabled Phillips 66 to sell the assets for about 10 times EBITDA, which is a lot higher than the assets were being valued inside Phillips 66. Because of this, these drop-down transactions create tremendous value for Phillips 66 because it can realize the vast differential in the EBITDA multiple.
As the below slide from the analyst day shows, Phillips 66 has already unlocked tremendous value already by simply creating the master limited partnership.
Source: Phillips 66 investor presentation (link opens as a PDF).
Even more value can be unlocked as Phillips 66 sells down additional assets. This is because it still has a number of assets that can be used to capture the value differential as investors continue to value the whole company for about a six times EBITDA multiple due to its more volatile refining segment. By selling the more stable, tax advantaged midstream assets into Phillips 66 Partners at a multiple of more than 10 times EBITDA will see a major uplift in value for the whole company.
Creating a pipeline of growth
In addition to owning a number of assets that could be dropped down, Phillips 66 is investing to build additional assets to add to its pipeline of drop-down candidates.
Source: Phillips 66.
For example, earlier this year Phillips 66 announced that it was investing $3 billion on two new midstream growth projects to take advantage of America's energy boom. The projects include the Sweeny Fractionator One and the Freeport Liquefied Petroleum Gas Export Terminal. The Sweeney Fractionator should be online by the end of next year while the Freeport LPG Export Terminal should be online by 2016.
During the analyst day, the company's management team noted that while it would spend $3 billion to build these assets, it could create even more value later on. In fact, it suggested that it could unlock another $2 billion in value as these assets could be sold down to Phillips 66 Partners for as much as $5 billion because the tax structure will allow the assets to fetch a higher EBITDA multiple. Such a future transaction would likely be very accretive to Phillips 66 Partners and very profitable for Phillips 66.
Investor takeaway
We've seen a number of energy companies create MLPs over the past few years to take advantage of the IRS' special tax loophole that's highly valued by investors. Not only is it creating tremendous value for the parent company but it's providing it with additional growth capital. That capital is helping to fuel America's energy boom and creating a win-win scenario for investors of both companies.
