He buys whole companies for sound managements with good franchises, companies that can make more money without the distractions of being in the public market. The most recent example of this is Heinz. An older example was GEICO.
He will also buy pieces of companies for undervalued assets existing management can capitalize on. Thus, in the third quarter of the year Buffett bought more Exxon-Mobil (XOM) and lightened up on Conoco-Phillips (COP), which spun-out its refinery operations in 2012.
What did Buffett see here? I think he saw history.
The oil industry has a set pattern of boom, bust, and consolidation. Drillers lead the boom, overproduction causes the bust, and consolidation creates the lasting value, based on capital and control of the product after it leaves the wellhead.This is how Standard Oil was built. As Ron Chernow described in his book, Titan, John D. Rockefeller's Standard Oil scaled downstream businesses, transport and refining in the late 19th century, then used that control to squeeze rivals out of production. Capital created efficiency. The U.S. shale boom is now reaching the stage where downstream capital matters. Getting oil and gas to market takes money, and right now a lot of money is literally being burned away. Gas is in glut - it's busted - and producers are flaring it to get at the oil around it. Exxon-Mobil bought a huge gas producer called XTO Energy four years ago, and has since been adding to that holding, becoming the largest producer of natural gas in the country. Right now they're getting just $3.60/mcf (volume of 1,000 cubic feet) for that U.S. gas that can change, once capital is put to work creating export markets for the product. A number of companies are doing just that, including Cheniere Energy (LNG) and Kinder Morgan (KMP). There is enormous arbitrage to be done in natural gas, as shown in this chart from the Federal Energy Regulatory Commission. Markets in Asia and South America are paying four times more for the product than Americans are. Exporting gas is a capital-intensive business, but Exxon-Mobil has lots of capital. Exxon-Mobil is also the world's largest oil refiner, handling nearly 5.8 million barrels per-day according to Petro Strategies. Refining is another way to arbitrage fuel prices. The "spread" between U.S. and world oil prices has been widening since summer and is now about $13/barrel. This means Exxon-Mobil can export refined products at a solid profit. Exxon-Mobil also has lots of oil, with proven reserves worth $2.2 trillion according to recent estimates. This puts a floor under the equity value of $411 billion. Buffett's downside risk here is very limited. Buffett has also displayed his typical good timing in entering this opportunity. Exxon-Mobil has been heavily-shorted lately and this provides lift to the shares. Technical indicators are positive. Exxon-Mobil's liquidity means this is a stock Buffett can play for either the short-term, as a trade, or for the longer-term, as an investment. The natural gas market has turned from boom to bust and is ripe for a financial consolidation. The oil industry is following the same path. This is the history that built Standard Oil. Exxon was formerly Standard Oil-New Jersey and Mobil was once Standard Oil-New York. Together they're the best-positioned, most-undervalued play out there to drive a new wave of energy industry consolidation, based on downstream infrastructure and capital availability. It's been said before, but should be said again. Mr. & Mrs. Buffett did not raise no fool.
Written by Dana Blankenhorn. The author owns no shares in companies mentioned in this article.
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