Phillips to acquire Tosco for $7.49 billion


Sam Fletcher
OGJ Online

HOUSTON, Feb. 5�Industry analysts were buzzing Monday over Phillips Petroleum Co.�s surprise proposal to acquire Tosco Corp. for $7.49 billion in stock and debt, making the combined company the second largest US refiner in terms of capacity, behind ExxonMobil Corp.

Phillips and Tosco officials announced the acquisition agreement Sunday.

�I would have been less surprised if Tosco was buying Phillips� refining operation,� said Ray Ory, vice-president and manager of the Houston office of Baker & O�Brien Inc., an advisory firm for the refining industry.

Under the acquisition agreement, Phillips will issue 0.8 common share for each Tosco share and assume close to $2 billion of Tosco�s debt. That puts Tosco�s value at $46.50/share, a 34% premium over its closing price of $34.61/share Friday on the New York Stock Exchange, sources said.

Tosco, based in Old Greenwich, Conn., has grown through acquisitions from a single-refinery company in 1992 to become the biggest US independent refiner and marketer.

Phillips officials earlier were seeking a joint venture with another refiner to run the company�s refining and marketing operations while the Bartlesville, Okla., firm concentrated on its more profitable upstream operations. However, negotiations between Phillips and Conoco Inc. in 1996 on a possible joint venture fell through. Phillips also broke off a preliminary deal with Ultramar Diamond Shamrock Corp. in 1999.

�Phillips certainly was giving signs that it was trying to get out of the refining business instead of getting in,� said Robert Hermes, president of Purvin & Gurtz Inc., a Houston consulting firm. �Apparently, Phillips couldn�t get the price it wanted for its operations, so it decided to stay in the downstream market."

Margins high
Tosco has nine plants with 1.3 million b/d crude capacity, making it the third largest US refiner in terms of capacity, behind ExxonMobil and BP. Phillips is ranked 17 among US refiners, with three plants totaling 355,000 b/d (OGJ, Dec. 18, 2000, p.60).

Tosco made many of its acquisitions at bargain-basement prices. Analysts said Phillips seems to be acquiring Tosco at the top of the current refining cycle, after a rare year of fairly good annual returns for that industry. �That�s certainly a good deal for Tosco shareholders,� Ory said.

Profit margins for refiners have improved in the last 12-18 months with growing demand for refined products and increased oil production. But refining margins are now at an 18-month low in Europe in the face of a strong rally in oil prices and reduced demand for products.

Mounting losses forced several oil companies to cut their European refinery throughputs by 20%, with others advancing scheduled maintenance work during the downturn, industry sources reported Monday. Singapore, Asia�s swing refining center, also reported margins in the red.

Only US refineries are still profitable. But Gulf Coast refiners running US light crudes reported margins have deteriorated to $2.98/bbl from $3.60/bbl a week ago, sources said.

�February is usually the trough in refining profitability. What kept margins at a higher level to this point was demand for heating oil, but those inventories are rising again,� Ory said.

However, Tom O�Malley, Tosco�s chairman and CEO, foresees an extraordinarily strong cycle for the refining industry over the next 4-5 years.

The US market for refined petroleum products is growing at a glacial pace, �about 2%/year, optimistically,� said Hermes.

But no new refining capacity can be built and some existing capacity could be lost as a result of existing and pending government regulations pertaining to the environment and other issues.

�So if you�re in this business for the long-term, you have to buy existing capacity, hoping that it will be more profitable in the future than it has in the past. And at this point, there are fewer and fewer Tosco-like companies to be bought,� said Ory.

More immediately, Phillips officials figure to cash in on the greater efficiency of the combined companies, through estimated pre-tax synergies of $250 million/year.

Operations
They also apparently hope to capture some of Tosco�s magic.

O�Malley, 59, a former commodities trader, is Tosco�s largest individual shareholder. He managed Tosco�s phenomenal development. He will become vice-chairman of Phillips� board of directors and chief executive of the combined refining, marketing, and transportation operations when the deal is closed.

Those operations will be based in Tempe, Ariz., where Tosco Marketing Co. is now headquartered. That puts it a long arm-length from Phillips� Bartlesville headquarters, where only a small amount of the combined downstream operations, including research and development, will be located.

�The characteristics that made Tosco is what Phillips ought to be doing. It�s not so much a matter of O�Malley adapting to Phillip�s corporate culture as the question of whether Phillips can adopt Tosco�s culture,� Ory said. �Time will tell about that.�

There is little overlap between Phillips� and Tosco�s refining and marketing systems. �Phillips is basically oriented to the mid-continent, while Tosco is coastal,� Ory said.

Phillips� biggest refinery�with 205,000 b/d throughput capacity�is at Sweeny, Tex., near Houston, and it has another 130,000 b/d refinery at Borger in the Texas Panhandle. Its third and smallest refinery, at 25,000 b/d, is in the Salt Lake City, Utah, area.

Tosco�s biggest refinery, at 295,000 b/d, is at Roxanna, Ill. Other plants are at Linden, NJ: Trainer, Penn.; Belle Chasse, La.; two connected plants at Los Angeles; two connected pants at San Francisco; and Ferndale, Wash.

The acquisition will make the combined company the third largest US retail marketer of gasoline and refined products, with more than 12,000 outlets in 46 states, including 6,300 from Tosco under the �76 and Circle K brands, and 5,900 under its Phillips 66 brand. Tosco is the largest operator of company-controlled convenience stores in the US.

The combination will give Phillips more than a 15% share in the California, Oregon, Washington, and Arizona markets for refined products.

When BP acquired Atlantic Richfield Co. last year, public concerns over BP�s large Alaskan oil holdings and its major position in the West Coast refining and retail sales market caused federal officials to force a sale of the ARCO Alaska properties. Phillips Petroleum bought those properties for about $7 billion and nearly doubled its total reserves.

But analysts don�t expect similar problems with the Phillips-Tosco deal, because neither company has BP�s dominance in either the Alaska upstream or the West Coast downstream markets. Only Tosco�s Washington refinery processes Alaskan crude, said Ory.

However, some analysts are concerned that Phillips may become too reliant on refining as a result of the proposed acquisition. The combined refining capacity will be almost three times Phillips� current US production, according to industry sources.

The acquisition is expected to close by the end of the third quarter, pending the usual approval procedures.

Sam Fletcher can be reached at samf@ogjonline.com

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