Christopher Edmonds

Return to Article

High-Energy Refiner Mergers Narrow the (Oil) Fields

Christopher Edmonds

Talk about energy!

First, Valero (VLO - Cramer's Take - Stockpickr) agrees to buy Ultramar Diamond Shamrock (UDS - Cramer's Take - Stockpickr) for about $4 billion in cash and stock, creating the second-largest domestic refiner. The combined company will not only have the ability to refine almost 2 million barrels of oil every day (bpd), it will market its wares at more than 5,000 retail service stations in North America. Valero will also assume nearly $2 billion in Ultramar debt.

Second, after a tug-of-war with Royal Dutch Shell (RD - Cramer's Take - Stockpickr), Barrett Resources (BRR - Cramer's Take - Stockpickr) agreed to be acquired by Williams (WMB - Cramer's Take - Stockpickr) for more than $70 a share. (More on the Barrett-Williams deal coming shortly.)

The Valero-UDS deal calls for Ultramar shareholders to receive either 1.228 shares of Valero common stock or $55 in cash, a 29% premium to Ultramar's Friday close of $42.71.

Claiming the deal will be significantly "accretive to earnings and cash flow per share," Valero Chairman and CEO Bill Greehey said the combination creates significant economic efficiency. "We will benefit from enhanced financial performance through realization of numerous potential synergies among the facilities, including multi-refinery purchasing and inventory optimization," he said in a statement. "We estimate that these synergies will have a benefit in excess of $200 million annually."

The combination comes on the heels of Phillips Petroleum's (P - Cramer's Take - Stockpickr) February announcement that it will purchase independent refiner Tosco (TOS - Cramer's Take - Stockpickr) for $7 billion, which creates a company with 1.71 bpd of capacity. And, at first glance, it looks like Valero found a slightly better deal. "After the $200 million in cost savings, which could be a little light, Valero is paying slightly less than Phillips paid for Tosco," says Dan Pickering, director of research at Simmons, a Houston energy investment bank and a member of the TSC Energy Roundtable. "This looks like a fair price."

Pickering estimates Valero is paying about 11 times Ultramar's 2002 earnings for the deal. Phillips paid 12 times 2002 earnings for Tosco.

With refiners running near capacity and gasoline prices near record highs, profits could be gushing for refiners over the summer. And, with two blockbuster mergers in the sectors already this year, investors wonder who might be next.

"Refining is now a pretty small sector in terms of public companies," says Pickering. Remaining on the radar screen among independent refiners are Ashland (ASH - Cramer's Take - Stockpickr), Frontier (FTO - Cramer's Take - Stockpickr), Sunoco (SUN - Cramer's Take - Stockpickr) and Tesoro (TSO - Cramer's Take - Stockpickr). While all may see interest from investors looking for the next target, Pickering says additional acquisitions may not focus on companies, but properties. "Acquisitions may become more asset-based than company-based," he notes. "You have a lot of majors that have been looking to divest refiners and that is the most likely way Valero-UDS will play."

However, he does note one refiner that may be shopping. "You have to wonder if this pushes Sunoco to do something."

While the Valero-Ultramar deal creates the largest independent refiner, it also reduces the flexibility and quality of Valero's portfolio. "Valero is trading some flexibility on the high end for scale and cost savings," says Pickering, noting that may prove to be the right move. "In this business, bigger has been better."

The only stumbling block might be antitrust concerns, although they could be satisfied by insignificant divestitures, possibly on the retail front. "California will likely be the area of closest scrutiny," says Pickering.

While Valero may see some of the typical buyer's pressure in Monday trading, that isn't likely to last, as the combination is a company that energy investors will almost have to own. "The combination becomes the bellwether in the sector," notes Pickering. "It will become the go-to name for investors in the sector."