By James Thomson
The $25 billion energy giant Santos could be worth almost 40 per cent more if it splits its prized liquefied natural gas assets into a separate company, according to Melbourne-based fund manager L1 Capital, which has urged the Santos board to consider a break-up.
L1’s push for a strategic review of Santos’ portfolio has the broad support of several other Santos investors, including Wilson Asset Management and Tribeca Investment Partners.
Both L1’s $3.5 billion long/short fund, which is overseen by Raphael Lamm and Mark Landau, and its $1.6 billion activist fund, which is called the L1 Capital Catalyst Fund and overseen by James Hawkins, are holders of Santos stock.
While L1 has praised the operational performance of Santos under chief executive Kevin Gallagher, it has grown impatient with what it sees as the stock’s persistent underperformance, and believes the board should examine splitting its LNG assets from its conventional gas business.
Hawkins says that in the past two years, Santos has delivered total shareholder returns of just 11 per cent, while Woodside and an index of global peers, including Chevron, Shell, ExxonMobil, BP and ConocoPhillips, have delivered 70 per cent.
While Santos’ EBITDA is expected to grow 22 per cent between 2024 and 2027, it is trading on an enterprise multiple of just 4.2 times. This is materially lower than Exxon, Chevron and ConocoPhillips, which are trading at 5.7 times, 6.2 times and 6.3 times respectively, despite the market forecasting their EBITDA will decline over the next three financial years.
While L1 acknowledges this underperformance in part reflects concern over whether Santos’ controversial Barossa offshore gas project in the Northern Territory will receive regulatory drilling approval, it says a bigger issue is the market’s failure to properly value the group’s LNG assets.
It argues a company that houses Santos’ stakes in the PNG LNG project, the GLNG project in Queensland, the DLNG project in Darwin, the Papua LNG project and Barossa project would become one of the world’s leading pure-play LNG groups, with strong cash flows, low operating costs and a strong balance sheet.
The LNG business should be attractive to investors and a range of other global energy giants, many of which have expressed a desire to increase their exposure to LNG and could see Santos’ LNG assets as a takeover target.
“We believe a structural separation of Santos’ LNG assets has significant strategic rationale and financial merit,” Hawkins says.
“It is clear to us that the LNG assets are not being valued sufficiently in Santos’ current form, and we believe they could be worth more than the entire current market cap of Santos.”
A Santos spokesman said: “Santos welcomes feedback from investors and regularly reviews opportunities to create shareholder value.”
L1’s activist campaign comes less than two years since Santos completed its $21 billion takeover of Oil Search, a fact that may mean the Santos board is reluctant to consider structurally separating the group.
But Lamm says the LNG business and the rump of Santos – which would house Santos’ domestic gas businesses on Australia’s east and west coasts, plus the Dorado project off the coast of WA, the controversial Narrabri project in NSW and the Pikka gas project in Alaska – could be worth more than $10.50 a share on a sum-of-the-parts valuation, 37 per cent above Santos’ current share price of $7.66.
“A separated LNG business would become a leading listed LNG pure-play exposure, with long-life assets, clear growth agenda, and growing exposure to the spot market, highly sought after by investors given continuously increasing LNG demand,” he says.
“The remaining non-LNG assets of Santos would also have significant appeal in their own right. We believe there is a need for an effective local gas champion that can bring future supply, such as Narrabri, into an increasingly short Australian gas market.”
L1’s proposal has galvanised other investors. Ben Cleary, chief executive of Tribeca Investment Partners, went public last year with an argument that Santos could be worth as much as $19 a share if the market was to recognise the inherent valuation in its decarbonisation assets, including its carbon capture and storage projects, and its blue hydrogen initiatives.
“Twelve months later, clearly the market hasn’t unlocked the value that we see,” he says.
Cleary is supportive of a formal strategic review process, and suggests that separating the LNG assets and conventional gas assets may be just one option. Separating Santos’ carbon-producing assets and its decarbonisation projects may be another approach, while splitting its domestic and international assets could also be worthy of consideration.
Santos’ willingness to pursue a separation so soon after the Oil Search merger is one stumbling block to the L1 plan. But another may be the attractiveness – or lack thereof – of the leftover gas business.
Wilson Asset Management’s John Ayoub, who is also supportive of L1’s push for a strategic review, says the demerger of South32, a collection of assets that BHP no longer wanted, shows “leftover” businesses can take their time to find their footing and their right valuation, and careful consideration needs to be given to the way Santos splits its portfolio.
“It is about ensuring that it’s balanced and you realise full value for all of the assets,” he says.
However, there is no question that the bulk of Santos’ valuation rests with the LNG business. Firetrail Investments’ portfolio manager Blake Henricks backed L1’s view that the LNG assets are the most valuable part of the group.
“We think the LNG assets are the jewel in the crown. They are long-life, low-cost assets, and we continue to believe that gas will play a role well into the future. We are supportive of anything that is going to unlock value.”
Santos CEO Kevin Gallagher told The Australian Financial Review Energy & Climate Summit last week that there would be a role for gas well beyond 2050, and nations including the US, Britain and Japan had realised the importance of gas.
“I’m very confident the reality … of what the world wants, versus what it says it wants, will mean there’s a very big place for gas in the future,” he said. “Australia is behind the rest of the world around how it views gas.”