Takeover decisions clear the air as Origin deal blasts BG out of the picture

THERE was a sense of closure in the air yesterday as the markets rallied and two giant takeovers were decided. The US Government's decision to prop up the balance sheets of Fannie Mae and Freddie Mac was most important for what it said about the political limits of the debt crisis.

The $US200 billion ($A245billion) support package confirmed that the US Government (and US taxpayers ultimately) will not allow the two groups that account for half the $US12 trillion US mortgage market to collapse, and the strong market rally was justified on that ground alone.

In this market, St George's board finally unequivocally backed Westpac's $18 billion share-exchange offer after extracting a 28-a-share, $170million sweetener and on the strength of it, committing to a $100 million break fee that it had initially refused.

With no counter-bidders looming and the bid declared fair and reasonable by expert Grant Samuel even before the sweetener was added, Westpac is now home and hosed. Integration work that was being held up while St George squeezed the pips has begun.

And Origin Energy has blown apart BG group's $15.50-a-share, $13.8 billion takeover bid by agreeing to put its coal seam gas assets and liquefied natural gas export project into a joint venture with America's ConocoPhillips. The $9.6billion staged payment deal illustrates the enormous latent value in Australia's resource sector by valuing Origin's coal seam gas assets at 40% more than BG's offer for the entire Origin group, which includes electricity generators and gas and electricity retailing.

ConocoPhillips beat proposals from Shell, BP, and Santos and its new Queensland coal seam gas partner, Petronas of Malaysia, and has set an impossibly high bar for BG to clear, with Grant Samuel now saying that control of Origin should not pass for less than $28.55 a share.

The joint-venture agreement vindicates Origin's decision to oppose the BG offer after going within a hair's breadth of embracing it in May.

As Origin prepared to back BG's offer, chief executive Grant King's suspicion that $15.50 did not fully recognise the value or extent of the group's coal seam gas reserves was backed by an independent report that doubled the size of Origin's proven, probable and possible coal seam gas resource in Queensland's Bowen Basin, and - the clincher - by Petronas' $2.6billion purchase of a 40% stake in Santos' adjacent coal seam gas acreage.

The Santos-Petronas deal inferred a coal seam gas value of $1.65 a gigajoule, well above the implied coal seam gas price in BG's offer. Origin walked away, and has been sparring with BG since, with BG arguing that subsequent deals, including Shell's purchase of coal seam acreage from Arrow Energy for between 50 and 70 a gigajoule, valued coal seam gas reserves more accurately. There was debate about Origin's reserves too, but the value of the coal seam gas was the big question, and ConocoPhillips has answered it emphatically.

It will pay $6 billion for a 50:50 joint venture with Origin, $1.15 billion to cover Origin's cost of developing the LNG project up until the final go-ahead around the end of 2010, and advance Origin $US500million for construction of each of an expected four LNG production trains.

On that basis, it is valuing the coal seam gas reserves at $1.88 a gigajoule. And while companies can and do pay too much for assets, ConocoPhillips is the largest coal seam gas producer in the US, with four decades of experience in LNG projects, including Australia's second, in Darwin.

It was an underbidder on the Santos auction, and transferred that knowledge to the Origin project. ConocoPhillips executive John Lowe said the group assessed the quantity and quality of Origin's coal seam gas (he is confident reserves are still significantly understated), how many wells need to be drilled to extract it (lots, because coal seam gas does not flow freely), and the proximity of the gas to the planned LNG plant in Gladstone, and to LNG markets in Asia, where ConocoPhillips is already a supplier.

That result was an economic lifetime value for the proposed project, which was discounted to produce a present-day value, and ConocoPhillips' offer.

The simple conclusion is that Origin and its adviser, Macquarie, were right to see the message in the Santos deal and resist BG, and right to accelerate plans to monetise its coal seam gas reserves by fielding offers on them.

BG erred by bidding for all of Origin when it only really wanted the coal seam gas assets. It had the expertise to take the entire company, and probably calculated that nobody else would follow with a full bid. Nobody did - but Origin changed the game by auctioning the coal seam gas assets separately, and BG was unable, or unwilling, to refocus and pay up.

The ConocoPhillips deal transforms and, in a sense, completes Origin, which was spun out of Boral and listed at just $1.54 a share in February 2000. The upfront payment will leave it cashed up with no net debt, and underlying earnings per share will be boosted by more than 35% over the remainder of the year if the initial $6 billion payment is banked by the end of next month, as planned.

The annualised earnings per share uplift is more than 55%, and Origin will spread the joy by quickly declaring a special 25-a-share, $225 million dividend, and launching a $1.275billion on-market share buyback. But even then its balance sheet will be lazy. With the NSW power sale in tatters and no obvious big-ticket acquisitions looming, a billion-dollar-plus off-market buyback is likely to be the third component next year.

mmaiden@theage.com.au