Is this Deal Another Waste of Shareholder Capital?

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Do you ever wonder if companies really have a plan when they are flipping assets amongst each other?  Whenever I read about an asset sale I’m reminded of something Warren Buffet said in his owner’s manual to shareholders,

“You should be fully aware of one attitude Charlie and I share that hurts our financial performance: Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns. We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations. We hope not to repeat the capital-allocation mistakes that led us into such sub-par businesses. And we react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures. (The projections will be dazzling and the advocates sincere, but, in the end, major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand.) Nevertheless, gin rummy managerial behavior (discard your least promising business at each turn) is not our style. We would rather have our overall results penalized a bit than engage in that kind of behavior.”

If the world’s greatest investor isn’t interested in selling off parts of his company, why does it seem like no one else is following his lead?  One industry in particular, the domestic refining industry, an industry that Buffett’s starting to fancy, has been involved in its fair share of deal making this year.  What I want to know is who are these deals really creating value for: shareholders or investment bankers?

Take the latest deal where BP (NYSE: BP) announced they were selling their Carson refinery in California to Tesoro (NYSE: TSO) for $1.18 billion.  In addition to the refinery they are getting BP’s marketing and infrastructure operations in the area as well as $1.3 billion of inventory bringing the total value of the deal to $2.48 billion.  For BP this is another in a string of asset sales in an effort to raise cash after the Gulf of Mexico disaster.  Tesoro on the other hand is adding to their existing west coast operations in a deal that will boost earnings after the deal closes sometime next year. 

This is a great deal for Tesoro if they can get FTC approval which could be tricky given that it would boost their market share to 25% in the supply zone.  One of the keys to the deal for Tesoro is their ability to drop down the non-refining assets to their MLP, Tesoro Logistics (NYSE: TLLP).  These storage and distribution assets include 100 miles of pipeline, three marine terminals, four land storage terminals and four product marketing terminals.  What that really does is simply ice the cake for Tesoro as the refinery they are acquiring is right next door to their Wilmington refinery.  When I say right next door, I mean that literally as just a fence separates the two and by merging the entities they’ll be creating the largest refinery west of Texas. 

For Tesoro and Tesoro Logistics it is pretty easy to see the value being created by this deal, but why is BP selling?  I touched on it earlier, but they’re still trying to build up their capital base following the disaster in the Gulf of Mexico.  They’ve been selling a lot of assets and while shareholders of the company have to hope they are getting good values from these businesses, truth is selling any cash generating asset is something Buffett would frown upon.   

In the case of refineries though, they’re not always the best at generating consistent cash flow.  That’s likely one of the reasons that this deal comes on the heels of several east coast deals with both Phillips 66 (NYSE: PSX) and Sunoco (NYSE: SUN) selling off refineries in an effort to reposition their asset portfolios.  In each case they were selling off idled or soon to be idled refining assets because they couldn’t generate a positive return.  They were also selling the asset to free it to be run in an atmosphere where it could be run at a higher value than what their business model would allow. 

While Buffett would advocate to never sell a business, that’s not always practical for all of those non-Buffett companies out there as sometimes a business just doesn’t fit in with the portfolio of assets a company owns.  While that might be fine for Berkshire Hathaway’s (NYSE: BRK-B)’s conglomeration of businesses, it doesn’t necessarily mean it’s the best practice for everyone else.  That's why I think it is just as important to determine why someone is selling as it is to decipher why someone else is buying.  BP needed the cash, Phillips 66 and Sunoco couldn’t generate consistent returns, both good reasons to be a seller.  In the end, I think shareholders came out as the winners, though I’m sure the bankers did just fine. 

latimerburned owns shares of Phillips 66 and has an options position on Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Motley Fool newsletter services recommend Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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