Why Phillips Made a Shrewd Deal for Tosco

Compared to other recent high-profile deals, Phillips paid a much lower multiple by at least six different measures.
Craig SchneiderFebruary 7, 2001

Is Phillips Petroleum Co. paying a large premium to buy Tosco Corp. at the top of the market?

Yes, according to most experts quoted in the general press. “They’re almost not leaving any margin for error,” Fadel Gheit, Fahnestock & Co.’s well-regarded analyst, tells CFO.com.

However, if you compare the price Phillips is paying to at least two other recent high-profile deals, you can easily conclude the company is actually getting a bargain if you use at least a half-dozen common industry measurements.

On Monday, Phillips said it would shell out 0.8 share for each of Tosco’s 161 million shares, a 34 percent premium to Tosco’s closing price on Friday, making it a $7.49 billion deal.

Once completed, Phillips will become the country’s second-largest refiner. Given the unpredictability and volatility of the refining business, Gheit questions the wisdom of the deal.

“Fat [margin] years are the exception, not the rule,” he says. More likely, if the industry experiences a couple of good years, it then typically suffers through a few lean years.

And, right now he thinks the industry is headed for that inevitable down-cycle. “Refining margins in Europe are absolutely collapsing. That might affect margins in this country,” he warns. This suggests that Tosco snookered Phillips.

Not so fast.

For one thing, Tosco announced last week that its fourth-quarter earnings more than tripled to a record $1.07 per share on strong refining margins. And many analysts are confident that refining margins will continue to grow in the near future.

So, how do you value Phillips’ deal? In general, several considerations come into play, such as the number of oil barrels produced per day, the location of the refineries, and the amount of premium, or lighter, grade product that the refinery produces per barrel.

Gheit believes that in the Phillips-Tosco deal, the advising investment bankers worked off valuations from smaller deals involving pure refining operations such as Valero Energy Corp.’s acquisition of the Benicia, Calif. refinery from Exxon for about $800 million. It produces 35,000 barrels a day.

Tosco owns eight U.S. refineries that can process 1.35 billion barrels a day of crude oil.

In fact, according to CommScan LLC, a New York-based data provider, the Phillips Petroleum-Tosco deal stacks up as a bargain compared to two other recent deals—El Paso’s recent purchase of Coastal Corp. for $22.5 billion in stock and debt and Chevron’s pending $35 billion all-stock purchase of Texaco. Click here to read more about Chevron-Texaco

For example, under Phillips’ proposed price tag, its enterprise value (which is the price tag of the deal plus assumed debt)-to-earnings before interest, taxes, depreciation and amortization (EBITDA) is 5.6 times, while its Enterprise value to EBIT (earnings before interest and taxes) is 7.1 times.

El Paso’s deal worked out to an enterprise value-to-EBITDA ratio of 16.7 and an enterprise value-to-EBIT ratio of 25.4.

In the Chevron-Texaco deal, the multiples were 9.4 and 14.2, respectively.

The equity value of the Phillips deal (which is the price tag excluding assumed debt) compared to EBITDA is 4.7 times and 5.9 times EBIT.

This compares to 19.3 times and 18.6 times respectively in the El Paso deal and 7.3 times and 11.2 times in the Chevron deal.

The enterprise value of the Phillips deal compared to total assets is roughly equal while the equity value to total assets is 0.8 times.

On the other hand, El Paso’s deal worked out to 1.6 times and 1.2 times respectively while the Chevron deal computed at 1.5 times and 1.2 times.

So, maybe Phillips knows what it is doing, after all.