Company: Phillips 66 (PSX)
Business: Phillips 66 is an energy manufacturing and logistics company. It operates through the following segments: midstream, chemicals, refining, and marketing and specialties. The midstream segment provides crude oil and refined petroleum product transportation and processing services, as well as natural gas and natural gas liquids transportation, storage, fractionation, gathering, processing and marketing services. The chemicals segment consists of Phillips 66’s 50% equity investment in Chevron Phillips Chemical (CPChem), which manufactures and markets petrochemicals and plastics on a worldwide basis. The refining business refines crude oil and other feedstocks into petroleum products, such as gasoline, distillates and aviation fuels, as well as renewable fuels, at 12 refineries in the U.S. and Europe. The marketing and specialties segment purchases for resale and markets refined petroleum products and renewable fuels.
Stock Market Value: $57.06B ($129.70 per share)
Activist: Elliott Investment Management
Percentage Ownership: n/a
Average Cost: n/a
Activist Commentary: Elliott is a very successful and astute activist investor. The firm’s team includes analysts from leading tech private equity firms, engineers, operating partners – former technology CEOs and COOs. When evaluating an investment, the firm also hires specialty and general management consultants, expert cost analysts and industry specialists. The firm often watches companies for many years before investing and has an extensive stable of impressive board candidates. Elliott has historically focused on strategic activism in the technology sector and has been very successful with that strategy. However, over the past several years its activism group has grown and evolved, and the firm has been doing a lot more longer-term activism and creating value from a board level at a much larger breadth of companies. The firm’s activism has always been well thought out and the detailed analysis it presented here is evidence of that.
Behind the scenes
Activist investors like to claim that they are “amicable” or “constructive.” While we do not generalize like that, it is hard to imagine a more amicable and constructive activist campaign than what Elliott is proposing at Phillips 66.
Phillips 66 has underperformed peers Valero Energy and Marathon Petroleum by 45% and 191%, respectively, over the past three years and by 163% and 248%, respectively, over the past 10 years. Elliott thinks this can largely be attributed to the company’s shift in focus away from the refining segment and management’s poor execution in cost reductions, which has led to a loss of investor confidence.
Since his elevation to CEO in July 2022, Mark Lashier has committed to a strategic outlook that includes refocusing on the refining segment, cutting costs, targeting $14 billion of mid-cycle earnings before interest, taxes, depreciation, and amortization by 2025, selling $3 billion of non-core assets and increasing the company’s long-term capital return policy. Elliott wholeheartedly agrees with this plan and thinks it could lead to a $205 stock price. The first part of an activist campaign, convincing management that your plan is better than theirs, is already done here. The only thing activists like more than a management team agreeing with the activist’s plan is a management team that has its own plan that the activist agrees with.
But communicating a plan to the market is one thing, getting investors to believe that you can execute is entirely another. There has been a lack of shareholder trust here, much of which stems from the company’s AdvantEdge66 program in 2019, aimed at reducing costs. When implemented, Phillips 66 saw costs increase relative to peers, burning shareholders’ confidence in the management team’s ability to achieve its goals. The first step in rebuilding management credibility would be adding new directors to the board, particularly at the request of a shareholder. If those directors happened to have refining operations experience, that would give investors even more confidence that management is shifting their focus back to the refining business.
Elliott has significant experience in partnering with industry experts and has already identified candidates here with relevant expertise to fill two board seats. Elliott is not asking for a board seat for itself to debate with management. The firm is asking for two seats for two industry executives who would put management in the best position to execute on their plan. The best activists use board seats to support management in executing their plan, but they also will hold management accountable if they are unable to do so.
That is where Elliott’s plan B comes into play. If Phillips 66 adds two new directors approved by Elliott and still cannot deliver on performance targets over the next year, then it will need to take a path like the one Marathon Petroleum took in its transformation. This will include making appropriate management changes, closing the current $2 to $3 per barrel refining EBITDA gap between Phillips 66 and Valero and generating $15 billion to $20 billion from the sale of non-core assets, including their CPChem stake, European convenience stores and a portion of non-operated midstream stakes.
This should be an easy decision for the company, and we would expect it to quickly appoint two new directors identified by Elliott to the board. Given the tone and substance of Elliott’s outreach, it would be very surprising and disappointing to see this go to a proxy fight. However, if it did, we believe Elliott would be a lock to get at least two board seats on the 13-person board, particularly with the use of a universal proxy card.
Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.