Wilson Asset Management

By Angela Macdonald-Smith

Santos investors are baulking at a low-premium merger deal with Woodside Energy, even with the drawcard of creating an $80 billion Australian oil and gas “champion” with clout on the global LNG stage.

The deal in play after both companies confirmed early-stage talks late Thursday involves a scrip-based merger with a small premium, something unacceptable to Santos shareholders convinced the stock is seriously undervalued on the ASX.

Shares in Santos initially surged as much as 11 per cent early Friday as investors digested the news. The shares were up 5.9 per cent at $7.235 shortly before the close, in contrast to Woodside’s 0.5 per cent slide as investors in the Perth-headquartered producer fretted it may offer too much.

“I’m very interested to see details because I think Santos is incredibly undervalued at its current price and we need to see something pretty compelling from Woodside to make it worthwhile,” said Matt Haupt at Wilson Asset Management, which has been pushing for Santos to consider moves that would unlock value.

“I’m not sure we’re going to get a knockout deal here. We still think Santos is worth much more than even today’s share price, so we’ll see what happens.”

Premiums of between 8 per cent and 14 per cent typical of some recent deals would still undervalue Santos, he said.

Katana Asset Management’s Romano Sala Tenna said that as a Santos shareholder, the concept of a nil or small-premium merger was problematic given Santos stock has not seen the upward rating in its valuation that Woodside has.

“We do think on a relative basis if it was a like-for-like on today’s valuation that the value would accrue to Woodside shareholders,” he said.

WaveStone Capital principal Raaz Bhuyan also said Santos was undervalued relative to Woodside, meaning that a “reasonable” premium would be required.

James Byrne, an analyst at Citi, said that Woodside finding the right value to appease frustrated Santos shareholders is likely to be the biggest sticking point to a merger, but that Woodside’s big cost of equity advantage over Santos means an outcome north of $9 a share “is plausible”.

A full merger would mean production at the combined company of about 285 million barrels of oil and gas, taking it comfortably within the top 10 largest exploration and production companies worldwide in terms of output, said UBS energy analyst Tom Allen.

The portfolio would be about 70 per cent weighted towards gas or LNG, making it unique among large cap global players, he noted.

Bernstein Research analyst Neil Beveridge said the merger would create an LNG “powerhouse” with 16 million tonnes a year of supply, accounting for 15 per cent of Australia’s LNG exports.

‘Can’t see the rationale’

The portfolio would include stakes in the North West Shelf venture, the country’s biggest and oldest LNG producer and the prized PNG LNG venture in Papua New Guinea, most of the Pluto LNG venture, and chunks of both the GLNG venture in Queensland and Darwin LNG in the Northern Territory.

But Allan Gray portfolio manager Simon Mawhinney, a holder of shares in both Woodside and Santos, said he saw no sense in a merger at all and cast doubt on whether the scale and diversification that would result were of value for investors.

“We can’t see the rationale for a tie-up between Santos and Woodside,” he said.

“There are no synergies to speak of, if nothing else there may be forced divestments from gas assets, which is not ideal.

“And the diversification benefits that a combination of Woodside and Santos would achieve can be achieved independently of a transaction.”

Mr Beveridge and other analysts also pointed to several hurdles, including competition issues around the companies’ combined domestic gas interests, on both the east and west coasts, and sensitivities around conditions that could be imposed by the South Australian and the Papua New Guinea governments,

In Adelaide, South Australian Energy Minister Tom Koutsantonis threatened to use the state government’s regulatory powers to protect the Santos head office from being shifted should any merger with Woodside proceed.

“The South Australian government will not be a bystander here,” he said. “There are regulatory powers that we have … we will use every part of our regulatory toolkit.”

Mr Koutsantonis said it was early days in any merger talks but pointed out that Santos was the largest company in South Australia and the state government would do its utmost to protect the headquarters and the jobs there. He said he wanted the CEO and CFO position of any merged company to be based in Adelaide.

A shareholder cap which previously prevented any entity owning more than 15 per cent of Santos was officially removed in 2008 after having been in place since 1979 as a mechanism to prevent corporate raider Alan Bond seizing control of vital oil and gas assets in the north of the state.

Mr Koutsantonis said that would not be re-implemented, but Santos was a hugely important company for the state. “The first two letters of Santos stand for South Australia.”