How Phillips 66 could amicably build shareholder value with activist Elliott.

Company: Phillips 66 (PSX)

An energy manufacturing and logistics company, it operates through four segments: midstream, chemicals, refining, and marketing and specialties. The midstream segment provides transportation and processing services for crude oil, refined petroleum products, natural gas, and natural gas liquids. The chemicals segment is a 50% equity investment in Chevron Phillips Chemical, which manufactures and markets petrochemicals and plastics worldwide. The refining business refines crude oil and other feedstocks into petroleum products, such as gasoline, distillates, and aviation fuels, at 12 refineries in the U.S. and Europe. The marketing and specialties segment purchases and markets refined petroleum products and renewable fuels.

Stock Market Value: $57.06B ($129.70 per share)

Activist: Elliott Investment Management

Elliott is a highly skilled and successful activist investor with a team of experts from top tech private equity firms, engineers, and former technology CEOs and COOs. The firm's investment strategy involves hiring specialty and general management consultants, expert cost analysts, and industry specialists. Elliott has a long history of focusing on strategic activism in the technology sector and has been highly successful with that approach. However, in recent years, the firm's activism group has grown and evolved, and it now does more long-term activism and creates value from a board level at a broader range of companies. The detailed analysis presented here is evidence of the firm's well-thought-out approach to activism.

What’s happening

On Wednesday, Elliott announced that it had invested $1 billion in Phillips 66 and was seeking up to two board seats.

Behind the scenes

Elliott's proposal at Phillips 66 is an amicable and constructive activist campaign.

Over the past three years, Phillips 66 has underperformed its peers by 45% and 191%, respectively. Similarly, over the past 10 years, the company has underperformed by 163% and 248%, respectively. Elliott believes that this can 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.

Mark Lashier, who became CEO in July 2022, has committed to a strategic outlook that involves refocusing on the refining segment, cutting costs, achieving $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 agrees with this plan and believes it could lead to a $205 stock price. The first step of an activist campaign, convincing management to agree with the activist's plan, has already been accomplished. However, activists prefer when management has its own plan that the activist agrees with.

To rebuild management credibility, the first step would be to add new directors to the board, particularly those with refining operations experience. This would give investors more confidence that management is shifting their focus back to the refining business, as the lack of shareholder trust stems from the company's AdvantEdge66 program in 2019, which resulted in increased costs relative to peers and burned shareholders' confidence in the management team's ability to achieve its goals.

Elliott has experience partnering with industry experts and has identified candidates with relevant expertise to fill two board seats. The firm is not seeking a board seat for itself to debate with management. Instead, the firm is asking for two seats for industry executives who can support management in executing their plan and hold them accountable if necessary.

If Phillips 66 fails to meet performance targets despite adding two new directors approved by Elliott, it may need to follow a path similar to Marathon Petroleum's transformation. This would involve making management changes, closing the $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.

The company should easily appoint two new directors recommended by Elliott to the board. It would be surprising and disappointing if the decision went to a proxy fight. However, if it did, Elliott would likely secure at least two board seats on the 13-person board with the use of a universal proxy card.

Ken Squire is both 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.