Unsolicited takeover
Santos (ASX:STO) has advised the market that it has received an unsolicited takeover offer from Harbour Energy. The offer is the third approach by Harbour Energy to acquire all the issued capital in Santos for a cash only consideration. The new offer is subject to conditions, including the approval of the Foreign Investment Review Board (FIRB). The Board of Santos has indicated that it is in negotiations with Harbour Energy with regard to the offer, and that shareholders take no action at this stage. The following figure shows the location of the Santos’s key assets:
Source: Santos (ASX:STO)
Harbour Energy is offering Santos shareholders US$4.98 per share (approximately A$6.47) to acquire all the share capital in Santos. The offer consideration valued Santos at around US$13.5 billion (A$17.6 billion).
The consideration comprises two components, a cash amount of US$4.70 (approximately A$6.11) per share and a special dividend of US28 cents per share (approximately A36 cents). The special dividend is expected to be fully franked.
Harbour Energy will fund the acquisition through a US$7.8 billion debt facility and the balance coming from equity sources.
The offer is subject to conditions, with a key condition being an approval by the FIRB. We consider the key conditions are not detrimental to the offer completing, except for the FIRB approval.
Santos (ASX:STO) holds an interest in three key liquid natural gas (LNG) processing facilities in Papua New Guinea (PNG LNG, Santos’s interest 13.5%), Gladstone (GLNG, Santos’s interest 30%) and Darwin (DLNG, Santos’s interest 30%). Santos also holds significant in-ground Australian natural gas resources and reserves, as well as oil reserves. The strategic nature of the two Australian based LNG facilities in GLNG and DLNG and the oil and natural gas resources that Santos has at hand, will be of significant interest to the FIRB. More so, given the FIRB rejected, in 2001 on strategic grounds, the Royal Dutch Shell offer for Woodside Petroleum. Harbour Energy is emphasising a commitment to support the Australian domestic energy market, post a successful acquisition of Santos.
Harbour Energy has made a habit of pursuing Santos following three unsuccessful attempts. The first was for A$4.55 per share lodged in August 2017, the second for A$6.25 (indicative) per share lodged in March 2018 and the third for A$6.37 (indicative) per share also lodged in March 2018. The premium to the share price at the time of the lodgements ranged from 25% up to 37%, with the most recent offer coming in at a 28% premium. The earlier bids all floundered on a valuation basis.
At an indicative price of A$6.47 per share, we consider the current bid consideration again appears to be somewhat short of the value we would ascribe to Santos. We believe Santos would carry a value in the range of A$6.75 to A$7.20 per share to acquire control of the company.
We premise our valuation on 2017 production of 59.5 million barrels of oil equivalent (boe) and production guidance for 2018 which is forecast to be in the range of 55 million to 60 million boe. The following chart shows recent annual boe production:
Source: Santos (ASX:STO)
The company’s 1P (proved) reserve stood at 470 million boe as at 31 December 2017 and its 2P (proved and probable) reserves came in at 848 million boe. The company’s 2P reserves are spread across three key regions in Australia in the Copper Basin, Queensland and Western Australia (WA) and a fourth in PNG. Pleasingly, the company’s organic reserve replacement ratio (RRR) has improved significantly over the past two years from zero in 2015 to 62% reported for 2017, with reserve upgrades reported for PNG, the Copper Basin and WA. We believe the company is now better placed both asset wise and now financially to bring about a further and as significant improvement in its organic RRR.
The company has now added the prospective Beehive prospect in the Bonaparte Basin in Western Australia, through an 80% farm-in. Santos will be required to complete a new 3-dimensional seismic survey and undertake one exploration well on the prospect. The following figure shows the company’s Northern Australian acreage (Beehive is highlighted):
Source: Santos (ASX:STO)
The Beehive resource best estimate is for 558 million barrels, within a range of 97 million barrels to 2,033 million barrels and a mean of 940 million barrels. The opportunity for success is estimated at 16%. As Members can see from the above figure the Beehive prospect is close to major oil and gas transport and processing infrastructure. The prospect also has the advantage of being in shallow waters of approximately 40 metres. The Beehive prospect has considerable optionality to bring any major find to commercial production.
The Beehive story becomes more compelling now that the company has been granted approval from The National Offshore Petroleum Safety and Environmental Management Authority to advance the development of the Barossa-Caldita blocks (Santos’s interest 25%, top dashed elliptic in the above figure). The Barossa field is estimated to contain a contingent resource of 4.3 trillion cubic feet (tcf) of natural gas. The 2C (mid-conversion probability) is net of 1.1 trillion tcf. The field is expected to have a life of 25 years.
Both the Beehive prospect, with success, and the Barossa-Caldita fields have the potential to be processed through the company’s Darwin LNG facility (Santos’s interest 11.5%). The Barossa-Caldita field will certainly improve further the value metrics of the DLNG plant.
The Cooper Basin and Queensland continue to be a source of growth for the company. The following figure shows the regional location of the Cooper Basin and the Queensland fields:
Source: Santos (ASX:STO)
The company plans to drill 70 to 80 holes over 2018 in the Cooper Basin and approximately 250 holes in Eastern Queensland. Both fields have the potential to feed to the GLNG to allow the company to fully utilise the plant through its own natural gas. Adding to the overall attractiveness of exploration, is the ability of the company to now complete exploration wells at very competitive capital costs.
The company has the assets that will deliver future growth and now can match that potential with an ability to deliver financially. We believe that this growth potential warrants an additional premium to gain control of Santos (ASX:STO). We are however of the view that the premium offered in the current bid price cannot be as easily dismissed as the preceding bids were. The Santos Board is now negotiating with Harbour Energy, rather than dismissing the offer immediately as under valuing the company.
We will monitor events close and will advise Members of appropriate action as the Harbour Energy bid unfolds. In the meantime, Santos (ASX:STO) will remain held in the Fat Prophets Portfolio.
