Activist Elliott has unfinished business at Phillips 66. How its plan to build value may unfold
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The Phillips 66 Los Angeles Refinery Wilmington Plant stands on November 28, 2022 in Wilmington, California.
Mario Tama | Getty Images
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 (M&S). The Midstream segment provides crude oil and refined petroleum product transportation, terminaling and processing services, as well as natural gas and natural gas liquids (NGL) transportation, storage, fractionation, gathering, processing and marketing service. The Chemicals segment consists of the company’s 50% equity investment in Chevron Phillips Chemical Company LLC (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. Finally, the Marketing and Specialties segment purchases for resale and markets refined petroleum products and renewable fuels.
Stock Market Value: $52.88B ($128.04 per share)
Phillips 66 shares over the past year
Activist: Elliott Investment Management
Ownership: ~4.6%
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. It 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 the firm’s activism group has grown, and it has been doing a lot more governance-oriented activism and creating value from a board level at a much larger breadth of companies.
What’s happening
On Feb. 11, Elliott issued a letter and presentation to the Phillips 66 board outlining “Streamline66,” a plan to resolve the company’s continued underperformance and poor corporate governance practices despite its portfolio of attractive assets. It includes the following steps: (i) streamline the company’s portfolio through a sale or spin-off of the midstream business as well as a potential sale of its interest in CPChem; (ii) initiate an operating review by committing to ambitious refining targets and closing the EBITDA-per-barrel gap with its peers; and (iii) increase oversight and bolster accountability of Phillips 66’s management team by adding new independent directors to the board.
Behind the scenes
Phillips 66 (PSX) is an energy manufacturing and logistics company. The company maintains four valuable asset segments, each offering scalability and strong competitive positioning. Its Midstream segment operates a vertically integrated wellhead-to-water natural gas liquids (NGL) business across the Permian and DJ basins. The Chemicals segment comprises their world-scale petrochemical joint venture CPChem. The Refining segment is one of the largest refining systems in the U.S. The Marketing and Specialties segment consists of a scaled fuels marketing business and production of specialty products. Despite the attractiveness of these assets individually, Phillips trades at a significant discount to its sum-of-the-parts valuation. While approximately 70% of the company’s earnings before interest, taxes, depreciation and amortization comes from the premium multiple Midstream, Chemicals and Marketing segments, which trade as high as 10-times EBITDA, PSX trades closer to the multiple of its lowest-valued Refining segment at 6.6-times. As a result, the company has significantly underperformed the average of its closest peers, Valero Energy (VLO) and Marathon Petroleum (MPC), in cumulative total return by 9%, 33%, and 97% over the past 1-, 3-, and 5-year periods, respectively.
Elliott first publicly engaged PSX in November 2023, when the firm sent a letter to the board of directors announcing its $1 billion investment in the company. Elliott criticized PSX for its history of underperformance, citing issues such as shifting away from and being poorly prepared to take advantage of the refining super-cycle in ’22 and ’23, rising refining operating expenditures (OPEX) per barrel in absolute and relative terms compared to peers VLO and MPC, and increasing costs relative to peers in the wake of a cost-reduction program. Elliott saw a potential stock price of more than $200 per share at the time, but the firm shared Wall Street’s concern that PSX was primarily an execution story.
Despite this, Elliott acted the way we want active shareholders to do so, as opposed to how they are perceived by many. The firm gave CEO Mark Lashier the opportunity to demonstrate meaningful progress on his targets of $14 billion of mid-cycle EBITDA by 2025, non-core asset divestitures of $3 billion and increasing PSX’s long-term capital return policy. They quickly and amicably agreed with the company to add two new directors with refining experience to the board. The company added Robert Pease, a former executive of Cenovus, to the board in February 2024, and agreed to continue to work with Elliott on identifying a second director in the coming months. The second director never materialized.
Now, more than a year later, Elliott has increased its position to $2.5 billion and is going to become more active in creating shareholder value, issuing a public letter and presentation to “Streamline66.” Elliott identifies three primary sources of PSX’s underperformance. First, the firm argues that the company’s intrinsic value has been obscured by its inefficient conglomerate structure, resulting in it trading in line with its lowest multiple refining segment despite a majority of EBITDA coming from its other premium businesses. Second, PSX’s operating performance has failed to meet management’s targets and profitability continues to lag peers. In 2024, PSX delivered annualized adjusted EBITDA of between $4.5 billion and $8.7 billion, well short of its $14 billion 2025 mid-cycle target. The company’s OPEX per barrel has risen in two consecutive quarters, and its EBITDA per barrel profitability gap has only widened versus VLO. Third, Elliott asserts that management’s continuous claim of a successful turnaround without any tangible financial results has eroded their credibility with investors. The firm also said the board has failed in its fundamental oversight duties, rewarding management with compensation disconnected from the company’s performance.
This is what has led Elliott to releasing its three-pronged plan to: (i) streamline PSX’s portfolio, (ii) review operational performance with an eye toward refining margin improvements, and (iii) improving management credibility with the addition of new directors. First, Elliott suggests spinning or selling PSX’s midstream assets, estimating that they could deliver approximately $40 billion to $45 billion as a standalone or in a sale to a strategic buyer. In addition, Elliott also suggests the sale of CPChem and JET, estimating that net proceeds of $48 billion from the three assets would be equivalent to 96% of the company’s current market cap. The raising of that amount of capital could allow PSX to repurchase between 60% and 90% of the company’s shares outstanding and increase the payout ratio to 100% of free cash flow like its refining peers. With enhanced oversight enabled by the addition of new directors with industry and operational experience, PSX could get on track towards improving its EBITDA per barrel and progress towards its refining targets.
Elliott estimates that this plan could yield a share price of approximately $200 per share. Moreover, the firm asserts that if PSX executes the playbook Elliott employed in its engagement at MPC, shares could increase to over $300. At Marathon, Elliott helped facilitate the addition of a new director, transition to a new CEO, closure of the gap in per barrel EBITDA with VLO, retirement of 50% of its shares outstanding since 2021, and sale of the Speedway retail operation for $17 billion in after-tax cash proceeds. Since Elliott sent its first letter to Marathon on Nov. 21, 2016, MPC has outperformed VLO and PSX by 56% and 116%, respectively.
Having a good plan is the first step, implementing it is another story. This time, Elliott will not be settling for one or two directors, especially after PSX failed to follow through on the agreement last time to add a second director with refinery experience. Elliott gave management time to execute. Management failed. Now, Elliott will do what the board is supposed to do, but did not: hold management accountable. Elliott does not explicitly state that it’s looking to replace senior management, but it does discuss management’s damaged credibility and eroded investor confidence, and that is hard to fix without replacing management. Moreover, Elliott does cite CEO replacement as the first item which led to successful turnarounds in their engagements at Marathon and Suncor. With the company’s nomination window closing this week and four directors on the 14-person board up for election, we expect Elliott will nominate a full slate of four directors, if only to preserve its options while discussing governance with the board.
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.
