Santos Takeover Far From Certain

This story features SANTOS LIMITED. For more info SHARE ANALYSIS: STO

The market is abuzz with speculation regarding a bid for Santos but brokers suggest progress on any offer would be difficult and success highly uncertain.

-Suggested offer price considered low in context of valuation
-Potential issues may arise from FIRB
-Hony/ENN need to be factored into the prospect
 

By Eva Brocklehurst

Speculation has filled the void on Santos ((STO)) as the market reacts to press reports that a new bid is about to be forthcoming from Harbour Energy. A cash bid of $5.30 a share is purportedly to be offered in coming weeks.

If it eventuates, the bid would represent a 13% premium to Citi's risked discounted cash flow valuation and imply a US$65/bbl oil price on average. Such a bid is similarly priced to a previous one from Scepter Partners in 2015 at $6.88 a share, which Santos rejected.

However, brokers suggest a deal is now significantly more difficult following the leak of any “preparation” to media, as the share price closed 13% above the level prior to the report. Santos has stated that it is not currently engaged in talks with Harbour Energy but did reject an approach by the private equity consortium in August, at $4.55 a share, on the basis that the indicative price was inadequate and sources of funds uncertain.

Coinciding with the speculation, Santos hosted a three-day visit to the Cooper Basin, Roma and Curtis Island. The main message Citi received from this tour is that the company's culture has changed and the focus is on reducing costs, growing production and improving efficiencies. The broker also found none of the disappointments that have usually accompanied such trips, which supports confidence in a turnaround for the company.

For now, Citi remains cautious about a bid proceeding, calculating a blue-sky value of $6.47 a share from de-risking growth and delivering on further cost reductions, although conceding this is likely to be a multi-year process. This value is conceived at a long-term oil price of US$55/bbl.

Deutsche Bank considers the indicative offer price low in the context of its valuation assessment, which implies a 2% control premium. The main issue for the broker in a transaction of this nature is the Foreign Investment Review Board (FIRB) approval. The FIRB, because of the significant domestic gas assets – these being the Cooper Basin, Western Australia, GLNG and Darwin LNG – would be involved.

The significant turnaround in the company has meant impressive cost reductions and a strengthened balance sheet, supporting Deutsche Bank's Buy rating. The exploration program planned for 2018 is also underpinning solid growth prospects in the Cooper Basin and GLNG.

UBS considers the plum in the Santos portfolio is the company's 13.5% stake in PNG LNG and notes that Total and Woodside Petroleum ((WPL)) have, historically, had an interesting acquiring a stake in this asset. PNG LNG represents 51% of the Santos net asset value. There is large uncertainty around the value of GLNG and the Cooper Basin but UBS acknowledges market sentiment towards these assets is improving.

If nothing else, Credit Suisse suggests Harbour Energy is a credible entity, noting a recent US$3bn acquisition of the Shell North Sea assets. Amid the speculation the broker is left wondering what potential issues may arise from an FIRB perspective. Particularly, given the state of the east coast gas market, what would be the government's view of the operator of both the Cooper Basin and GLNG being acquired by a relatively unknown, foreign entity?

A higher price is needed for Credit Suisse to be happy with the bid. The broker's oil price deck averages around US$54/bbl for the next 18 months so there is scope for upside and, if Santos truly believes in its growth opportunities, there is also scope for considerable de-risking of the valuation. In the broker's calculation at least a 30% premium to valuation is required for serious discussions to occur. So, at around $6.50 a share.

Hony/ENN

An important part of any bid scenario are Hony and ENN, with which Santos entered a strategic relationship in June this year. ENN is expected to be using Santos as its primary investment vehicle in upstream Australasian oil & gas. Collectively the two own 15.1% of the company.

The stake is important as Hony/ENN can counter offer if they so choose. Under a scheme of arrangement, however, 15.1% is not a blocking stake. Deutsche Bank points out that the board is also able to exclude ENN/Hony from any third party offers.

What is Harbour Energy?

Harbour Energy is an investment vehicle managed by US private equity firm EIG, designed to take controlling positions in upstream and midstream companies. Harbour Energy is run by former Shell Power & Gas CEO Linda Cook. The fund is backed mainly by large US pension and sovereign wealth funds. EIG has had a long presence in Australia particularly in Queensland CSG, previously partnering with QGC and, more recently, Senex Energy ((SXY)).

FNArena's database shows four Buy ratings, two Hold and one Sell (UBS) . The consensus target is $4.69, signalling -7.9% downside to the last share price.
 

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