Should You Bet on the Icahn-CVR Bout?

by Aaron Levitt | April 11, 2012 11:35 am

Rising oil prices and booming natural gas production has drawn much attention to energy sector over the last few years — even if it’s not all wanted. While battles have raged over pipelines, gas prices and fracking rights, the latest game of cat-and-mouse stems from “activist” investor Carl Icahn’s bid to enter the refining business.

After failed bids to acquire filmmaker Lions Gate Entertainment (NYSE:LGF[1]) and gain board seats at consumer products giant Clorox (NYSE:CLX[2]), the corporate raider has turn his attention to Sugar Land, Texas, refiner CVR Energy (NYSE:CVI[3]). Icahn plans on buying the 100-year-old company then selling it later on to one of the major refining firms.

Naturally, the board at CVR hasn’t exactly been thrilled with the investor’s hostile bid and soon adopted a poison pill defense.

While the proxy battle could go on for months, the real question is whether CVR is worth Icahn’s — or other investors’ — time.

A ‘Sweet Spot’ Refiner

After gaining at 14.5% stake in the company, Icahn has offered to pay shareholders a total of $2.26 billion, or $30 per share, for the refining firm. So far, shareholders had tendered about 55% of the refiner’s outstanding shares[4] to Icahn in response to the bid. In response, CVR launched a provision that if any investor gains ownership of more than 15% of the company, the board may issue additional equity to dilute the acquirer’s stake and stop them from gaining control. Icahn countered by saying if the board doesn’t decide in his favor, that “we will seek to hold them accountable to the maximum extent permitted by law.”

So why all the brouhaha? CVR’s main assets[5] include a 115,000-barrel-per-day oil refinery located in Coffeyville, Kan., a 70,000-barrel-per-day refinery located in Wynnewood, Okla., as well as the necessary pipelines and gathering systems needed to operate those assets. The firm also owns the general partner and a majority of the common units of CVR Partners LP (NYSE:UAN[6]). That MLP owns facilities that produce ammonia and urea ammonium nitrate fertilizers.

Two small refineries and an ammonium nitrate facility hardly seem worth fighting over. However, the key is where those plants are located.

As East Coast refiners like Sunoco (NYSE:SUN[7]) have struggled under rising Brent crude prices, those with access to cheap and abundant West Texas Intermediate (WTI) have flourished[8] over the last few years. Those refiners located inland are able to buy crude at the lower WTI benchmark — currently around $103 a barrel — and then sell gasoline at prices based on the global benchmark. North Sea Brent crude futures are currently trading northwards of $123.

That crack spread has been key to the recent success and rising profits at the inland independent refiners. CVR receives about 86% of its feed stock from WTI indexed oil. That has resulted in CVR realizing juicy gross margins per barrel of $15.13.

While CVR doesn’t feature the best refining margins of the major independent refineries, that $15 per barrel’s worth of profit is certainly attractive. Secondly, the firm’s small asset base (two refineries) and small market cap makes flipping it relatively easy. So one certainly can understand Icahn’s attraction to the firm.

However, the activist investor might have gotten ahead of himself on this one.

Icahn estimates that after he buys CVR, he can then sell off the firm’s assets for around $37 a share to major refiners like Valero (NYSE:VLO[9]) or Tesoro (NYSE:TSO[10]). I’m not so sure. First, there currently is a lot of extra refinery capacity on the global marketplace. Rising Brent prices have provoked many integrated oil firms into selling or spinning off their refinery assets, and there is glut of plants for sale. Realistically, unless your refinery is in Asia or South America, expect it to sit on the market a while.

The second wrench in Icahn’s cog is that the main advantage the inland refiners had is going away. With Enbridge’s (NYSE:ENB[11]) announcement that it will reverse the Seaway pipeline[12], the “cheapness” of WTI will be history. The reversal, along with a second pipe running parallel to the original, would send the glut of inland crude at the Cushing storage hub down toward the refineries on the Texas Gulf Coast. This would create a combined southward capacity of 850,000 barrels per day.

This doesn’t even take into account TransCanada’s (NYSE:TRP[13]) Keystone XL Southern Leg expansion or potential reversal of the key Capline pipeline[14], which runs the length of the Mississippi River. Speaking on terms of anonymity, one money manager told Barron’s, “Opening all these pipelines will relieve the stocks at Cushing and wipe out the Brent-WTI spread.”

Love It or Leave It?

CVR Energy is up more than 50% year-to-date — including 17% gains since Icahn disclosed his stake in the company in January — and CVI currently is trading for just under his buyout price of $30. Already, the market is estimating that the deal will go through.

While I generally don’t like corporate raider capitalism, I have to say current shareholders of CVR should take the money and run. It will take a few years to get all the pipeline capacity up and running, but that change is coming. The days of WTI trading for a significant discount to Brent are over, and the juicy crack spreads many of the inland refiners have been enjoying will end.

I’m not sure CVR, with its limited asset base, is really worth what Icahn is willing to pay. At the same time, Icahn most likely will be stuck with two refineries he can’t unload.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

  1. LGF:
  2. CLX:
  3. CVI:
  4. tendered about 55% of the refiner’s outstanding shares:
  5. main assets:
  6. UAN:
  7. SUN:
  8. have flourished:
  9. VLO:
  10. TSO:
  11. ENB:
  12. Seaway pipeline:
  13. TRP:
  14. Capline pipeline:

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