Legendary investor Warren Buffett has been able to negotiate special transactions numerous times in the past. Of course, Mr. Buffett has been able to negotiate special transactions in part due to his status as a famed investor and the desire on behalf of companies to have Berkshire (BRK.A) (BRK.B) as a shareholder. Perhaps the most notable special investments made by Buffett were Berkshire's investments in GE (GE), Goldman Sachs (GS), and later Bank of America (BAC). In each case, Buffett negotiated special terms under which Berkshire would own preferred shares in each company and warrants allowing Berkshire to purchase stock at higher prices. All three investments were tremendously profitable for Berkshire. In hindsight, Buffett appears to have gotten the best of each special transaction.
Just before 2013 came to a close, news broke that Berkshire was entering into a special deal with refining giant Phillips 66 (PSX). Under the terms of the agreement, Berkshire will give up 19 million, or $1.4 billion worth, of its 27.2 million shares in exchange for Phillips 66 specialty chemical unit. On news of the deal, Phillips 66 shares rose while Berkshire shares were close to unchanged. There are three important takeaways from this unusual transaction.
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1. Buffett Increases Exposure to Chemical Business
Perhaps the clearest takeaway from this special transaction is that Warren Buffett is increasingly bullish on the chemical business. Berkshire acquired Lubrizol for $9.7 billion in 2011 and the deal to acquire Phillips 66 specialty chemical business for $1.4 billion appears to be a bolt on acquisition. Buffett has already said that Lubrizol will oversee the Phillips 66 unit. Buffett's increasing exposure to the chemical business indicates that he believes the long-term outlook for the business is quite good. Given this, investors should take a closer look at other chemical plays such as Eastman Chemical (EMN), Dow Chemical (DOW), DuPont (DD), PPG Industries (PPG), and Huntsman (HUN)
2. Buffett Taking Profits on Refining Trade
It should be noted that if he wanted to, Warren Buffett could have simply purchased the Phillips 66 chemical unit outright for $1.4 billion and retained his full stake in Phillips 66. Berkshire has plenty of cash to do that. Instead, what Buffett has decided to do in this transaction is reduce his exposure to the refining business, which is currently booming and largely behind Phillips 66 recent move to all-time highs. This makes a lot of sense as Buffett only received Phillips 66 shares because he held a large block of Conoco Phillips (COP) shares prior to the spinoff. The refining business is really a commodity business, and largely a business without major competitive advantages. In other words, the refining business does not lend itself to a terribly wide competitive advantage moat that Buffett often talks about. Moreover, a lot of the refining gains are related to the widening spread between WTI Crude and Brent Crude. The wide spread has proved a key driver of refining profits. Betting on the direction of the spread between WTI Crude and Brent Crude does not fit Buffett's typical investment style and thus the reduction in exposure to the refining business makes sense. Perhaps investors sitting on large gains in refining names such as Valero (VLO), Tesoro (TSO), and Western Refining (WNR) should consider taking some profits at current levels.
3. Berkshire Likely Got The Better End of The Deal
As I mentioned early in this piece, Buffett has a history of doing quite well in transactions where he negotiates special terms. I believe the Phillips 66 will prove no different. However, it should be noted that for both Berkshire and Phillips 66, this deal is relatively small. That said, I certainly do not think this deal is a positive for Phillips 66. Phillips 66 management has already shown a lack of savvy when it comes to selling assets; in 2012, Phillips 66 sold a refinery to Delta. Had Phillips 66 waited to do this deal, the company would have likely been able to sell the refinery for a higher price. Phillips 66 vs. Buffett? I'd bet on Buffett.