Phillips Builds Refining, Sales with $7B Tosco Deal

After a positive surprise with its fourth quarter earnings performance, Phillips Petroleum continued to astonish observers last week, buying Tosco Corp. in a $7 billion stock transaction that will make Phillips the second-largest refining company in the United States with a capacity of 1.7 MMbbl/d.

The deal transforms Phillips into a more balanced major integrated oil company and contrasts with its recent efforts --- and the recent industry trend --- to expand more profitable exploration and production operations and shed low-margin refining.

Phillips' Alaska purchase last year from BP doubled its reserves to 4.4 billion barrels of oil equivalent (boe) and left many observers expecting more action on the upstream side this year. The Tosco deal, which amounts to a significant bet that refining margins won't collapse, apparently came as a shock to investors. Shares of Phillips were down more than 10% to below $52/share the day following the announcement but made a steady climb the rest of the week to end the day Friday at $55.75.

The purchase will give Bartlesville, OK-based Phillips another 1.35 MMbbl/d of refining capacity and 6,400 more gasoline stations. The merged company would have a strong position in Alaskan production and in refining and marketing operations on the West Coast, which has hindered regulatory approval of mergers in the past. Some observers believe the deal could trigger regulatory calls for divestitures. Phillips has daily production of 345,000 barrels of oil equivalent of crude from Alaska's North Slope. And Tosco adds three West Coast refineries, two operations in California and one in Washington with a total capacity of 324,000 b/d.

Under the terms of the agreement, Phillips will issue 0.8 Phillips shares for each Tosco share and will also assume $2 billion of Tosco's debt. The transaction is expected to close by the end of the third quarter. Phillips' board of directors also has authorized a $1 billion share buyback program.

"This strategic acquisition completes our foundation for accelerated and sustainable profitable growth. With our balanced portfolio of assets, scale, and financial flexibility, we can deliver the growth and value that our shareholders expect. We now have positioned our business to fully compete in the domestic RM&T marketplace, which, when combined with our strong E&P operations, puts us among the leaders in the integrated oil industry," said Jim Mulva, Phillips' chairman. "We are acquiring the assets and expertise of the country's largest independent refiner and marketer, and combining the complementary skills of the two companies, including Tosco's refining capabilities and convenience store expertise along with Phillips' branded wholesale skills and expertise in refining and fuel technologies."

Phillips expects the transaction to be accretive to earnings per share, taking into account anticipated annual pre-tax synergies of $250 million and the stock buyback. It will also improve net cash flow. The transaction will be accounted for under purchase accounting. Based on current consensus investment community estimates, year-end 2001 debt-to-capital ratio would be in the range of 37%.

The combined company's RM&T headquarters will be located in Tempe, AZ, with certain functions, including research and development, being located in Bartlesville.

"This is a tremendous transaction. Tosco has an excellent track record as both an operator of assets and a builder of value," said Mulva. "The combination will enhance our supply chain flexibility, balance our RM&T market portfolio, and enable us to benefit from both scale and synergies.

Phillips has 12,400 employees and $20.6 billion of assets, and had $21.2 billion of revenues in 2000. Greenwich, CT-based Tosco markets gasoline under the 76 and Circle K brands. Tosco currently has $28 billion in annualized revenues.

Rocco Canonica

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