Santos/Oil Search: STO proposes merger with OSH

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
21 July 2021, 4:00 PM
Sectors Covered:
Mining, Energy

  • Santos Limited (ASX:STO) has made an informal, indicative all-scrip merger offer to Oil Search (ASX:OSH).
  • Offering 0.589 new STO shares for every OSH share, currently values OSH at around A$4.25ps.
  • Not the largest premium, but OSH investor sentiment has dragged in recent years (made worse this week) boosting the appeal of a STO managed merged entity.
  • OSH has rejected STO’s offer on valuation terms, highlighting its recent share price increase has narrowed the premium on offer.
  • We are encouraged by OSH’s announcement that it will explore the merger to see if it represents value for shareholders.
  • Preliminary rough valuation of MergeCo supports the move, as does strategic considerations. We maintain our ADD rating on both STO and OSH.

STO approach OSH on merger

Santos Limited (ASX:STO) has flagged that it recently made an incomplete, non-binding, informal approach to merge with Oil Search (ASX:OSH) on 25 June.

An all-scrip bid, STO would offer 0.589 new STO shares for every OSH share held. At the time of the news this valued OSH at an equivalent of A$4.25ps, a narrow 12% premium to OSH’s late June share price.

In price terms, the offer is currently equivalent to ~A$18/boe (EV/2P reserve). A premium to their sector peer group average of A$14.3/boe (producers only). While a premium price per barrel of production (offer ~A$305/boe vs industry average ~A$164/boe), which is comfortably justified by OSH’s quality of earnings and Papua/Alaska growth projects.

OSH was quick to reject the offer on valuation grounds. Although did outline that it would explore the merger option to see if a subsequent offer can be made.

Timing is everything

Fortunate timing for STO, with news of the merger approach coming out in the same week that OSH announced the sudden departure of CEO Kieran Wulff due to unacceptable behaviour.

We expect OSH investor sentiment has taken a hit this week, and could see OSH holders more willing to accept a lower premium in return for seeing STO take over management of their investment.

What MergeCo might look like

MergeCo would be Australia’s largest oil & gas producer, in terms of market capitalisation, production and earnings.

The due diligence process, which STO expects to take 4-6 weeks and get underway shortly, is likely to deliver detailed synergy estimates. In the meantime we have made some preliminary estimates, which suggest A$1-$1.5bn in value might be created through a merger of STO and OSH.

Rationale checks out

Despite only operating its legacy PNG assets and undeveloped Alaskan oil project, OSH has corporate overheads equivalent to roughly 2/3 of STO. With the majority attributed to its Sydney head office operations.

The merger would also align STO/OSH’s PNG interests, while creating a formidable upstream player capable of surviving the approaching global energy transition (or at least adapt to it). 

We maintain our ADD rating on STO (login to view - unchanged TP) and OSH (login to view - unchanged TP), recognizing that both represent long-term value at current levels.

STO remains our top pick in the large-cap O&G sector, a view that would only be strengthened if it successfully merges with OSH (albeit price dependent).

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.


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