Why Buffett's Biggest Move in Q1 Was Selling $1.3 Billion in Phillips 66 Shares

Berkshire Hathaway sold some $1.3 billion in Phillips 66 shares last quarter, cutting Berkshire Hathaway's stake by some 64% in the midstream oil and gas giant. What gives?

May 29, 2014 at 11:36AM

Every quarter, large money-managers have to disclose what they've bought and sold via "13F" filings. While Fools don't always follow what the big money does, we can often glean an idea or two by tracing their footsteps.

Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) is an enormous conglomerate with a lot of moving parts, but legendary CEO and investor Warren Buffett's actions in the company's $100 billion-plus stock portfolio are closely watched. Given Buffett's amazing half-century track record as an investor, it's no wonder. He's known for having written "Our favorite holding period is forever" in one of his famous annual shareholder letters, and for managing a portfolio that backs up his emphasis on buying great businesses and holding them for the long term. Therefore it's a bit of a surprise to see that Berkshire's largest transaction in the first quarter was actually a sell. 

Sometime in the first quarter, Berkshire Hathaway sold 17.4 million shares of Phillips 66 (NYSE:PSX), valued at more than $1.3 billion. This is more than double the size of its next-largest transaction, a purchase of some $500 million in Verizon stock. What gives? Why was Berkshire's largest move in the quarter a sale? And why Phillips 66? Let's take a closer look.

Buffett Fool Annual Meeting
Warren Buffett at the Berkshire Hathaway 2014 annual meeting.

Tap dancing to the bank 
Back in December, Berkshire Hathaway and Phillips 66 announced that this would happen, when Berkshire agreed to acquire Phillips Specialty Products, Inc. (PSPI) for 19 million shares -- give or take, depending on the share price when the transaction closed -- in Phillips 66 stock. It looks like that transaction took place in the first quarter, and now Berkshire will begin rolling PSPI into its subsidiary operations. PSPI will fall under another relatively recent acquisition -- Lubrizol. 

What makes this a really brilliant move by Buffett is how effective it is at using the Berkshire capital -- in this case, stock. Buffett is always on the hunt for high-quality businesses that he can add to the company's family of subsidiaries, and PSPI, which makes flow enhancers that are important in moving oil and other oil derivatives through pipelines, is a great fit as a cash-generating machine. 

Add in that the majority of Berkshire's Phillips 66 shares were awarded when Phillips 66 was spun off from ConocoPhillips back in 2012 and that Berkshire has already started reducing its stake in ConocoPhillips in recent quarters, and it's no surprise that Buffett was willing to move on from the Phillips 66 stake. The icing on the cake? Since Berkshire isn't selling its shares -- at an enormous profit, given that they were essentially free -- and is trading them to Phillips 66 for an asset, the transaction is likely to be tax-free or, at least, very low in tax costs. 

This adds enormous value -- perhaps $300 million or more -- for Berkshire shareholders. Buffett remains the king of effective capital allocation.

What's in it for Phillips 66 shareholders? 
Phillips 66 management is committed to returning as much value as possible to shareholders and has identified share buybacks as a way to increase shareholder value. In the first quarter of 2014, the company acquired a total of 21.7 million shares, reducing the share count by 3.7%. Shares outstanding have been reduced a whopping 9.5% since the spinoff, barely two years ago. At the same time, the company has increased its dividend twice and is currently yielding 2.4%. 

As the company continues to buy back shares, its enormous free cash flow and income will mean more dividends shared across fewer shareholders -- a pretty compelling combination. 

Final thoughts: Trading assets isn't selling stock 
Buffett is a master at capital allocation, and it looks like this was a perfect scenario. Phillips 66 was looking to buy back shares, and Buffett was happy to trade Berkshire's Phillips 66 stock for a valuable, cash-producing asset that would fit within the existing companies Berkshire owns. 

This is an instance when shareholders of both companies benefiting from the transaction. Berkshire adds another cash producer, and Phillips 66 was able to reduce shares and keep its promise of returning value to existing shareholders without fundamentally altering its core business. Shareholders of both companies should be pleased with the result and not look too deeply at this for a reason to do anything with their shares. 

Warren Buffett has bought nearly 9 million shares of this company
Warren Buffett is so confident in this company's can't-live-without-it business model, he's actually gone to the well five times, and bought 8.8 million shares for Berkshire. An exclusive Motley Fool report details this company that already has more than 50% market share, and is at the front of an industry boom. Just click here to discover more about this industry-leading stock and join Buffett in his quest for profits!

Jason Hall owns shares of Berkshire Hathaway. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. 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.

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