Low ball and doomed to fail: Woodside moves on Oil Search

The Woodside offer for Oil Search has little chance but it raises some fascinating possibilities.

Summary: M&A is one of the only ways an oil company can expand at a time of low prices. Woodside has repeatedly tried to grow and failed. Oil Search’s assets include PNG LNG and a new LNG project. If the PNG Government, a shareholder in Oil Search, accepted Woodside’s offer, it would be left holding a foreign company instead of a local champion.

Key take-out: All investment banks that have analysed the deal doubt it can succeed in its current form and question why it has been made.

Key beneficiaries: General investors. Category: Oil and gas.

Woodside’s cut-price takeover bid for Oil Search sparked life in the entire Australian oil and gas sector. It is the biggest deal ‘proposal’ we have seen in a long time… but the one-for-four share swap offer proposed by Woodside is so low, at just 14 per cent above Oil Search’s pre-bid price, that it verges on the insulting and raises the question of why it was made.

The only way the offer can succeed is if it is increased substantially, preferably with a cash component – unless there are events other than a simple merger proposal occurring behind the scenes.

In some ways the Woodside move on Oil Search feels like Glencore’s “merger of equals” approach to Rio Tinto last year; low, unwanted, doomed to fail, and perhaps even designed to fall at the first obstacle, while serving as a precursor to another deal.

To put the bid in personal terms imagine Woodside as a rich old man, well past his prime, proposing marriage to a much younger woman who has a future in front of her and isn’t interested in getting hitched just yet.

That comparison might sound harsh but there are 10 things you need to know about Woodside, Oil Search and the wider market for oil and gas.

1. The oil price is crucial, and unless it rises by at least 50 per cent from its current $US50 a barrel to around $US75/bbl everyone in the oil and gas industry remains stuck in a tight spot with falling revenue, shrinking profits and, in the case of Woodside, with a generous dividend policy under threat.

2. Growth via merger and acquisition is one of the only ways an oil company can expand at a time of low prices. Discovery is the other option, but that’s even more difficult than M&A, fiercely expensive and can be a complete waste of money.

3. Woodside has tried repeatedly to grow beyond its roots on the north-west coast of Australia, and repeatedly failed. Exploration in a number of locations around the world has not succeeded and attempts to buy into projects, including an offer to joint venture a big gas discovery off the coast of Israel, was abandoned because of difficulties in dealing with the government of that country.

4. Despite its fabulous cash flows from the North West Shelf joint venture, in which it is a minority partner, and even more fabulous cash flows from the majority-owned Pluto LNG project, Woodside lacks growth options. It has become the old man of the Australian oil and gas industry, cash rich but growth poor with its next suite of projects (such as the offshore Browse and Sunrise LNG projects) either being economically marginal at current oil prices, technically difficult, or both.

5. PNG LNG is not the only asset of great value in Oil Search. It has other options on its drawing boards, including an expansion of the existing development and an entirely new LNG project based on the Elk and Antelope gas fields with the French oil giant, Total. For some mining and oil companies, PNG’s high levels of corruption and social unrest have made it a no-go country. Either Exxon Mobil or Total could counter Woodside’s takeover bid for Oil Search, but only with the blessing of the PNG Government.

6. The PNG Government is a 10 per cent shareholder in Oil Search, and a direct 16.8 per cent shareholder in the PNG LNG. If it accepted Woodside’s one-for-four offer for its Oil Search shares it would be left holding 2.5 per cent of a foreign company rather than 10 per cent of PNG’s local champion, and possibly face a loss on the Oil Search shares it only acquired last year at a cost of $US1.2 billion, using funds provided as a loan by the investment bank, UBS.

7. On the sidelines of the Woodside v Oil Search situation is the status of another shareholder in the PNG LNG project, the financially stretched Adelaide-based oil and gas producer Santos which has a 13.5 per cent interest in PNG LNG. Santos could be a seller of its stake in the gas project but it must first clear the standard terms of all Australian joint ventures, offer its portion of the business to existing shareholders. It is the pre-emptive clause which would have dissuaded Woodside approaching Santos but which might have been a factor in it making a direct approach for a merger with Oil Search in the hope of shaking up the joint venture.

8. The world’s LNG industry is changing, not simply through a surge in production that is being led by Australia’s six new projects which threaten to flood the market but also by a new entrant which threatens to destabilise the cosy, long-term, business arrangements between buyers and sellers of LNG. US-based Cheniere Energy is close to starting exports from its Sabine Pass project in the southern State of Louisiana with Europe as its target market, but also with the aim of developing a spot market in LNG which threatens to cut the global price because Cheniere’s base is low-priced US onshore gas.

9. The threat of a global LNG price war has been moving closer for some time with US gas producers keen to get their material into the higher-priced international market where prices have traditionally been set by long-term contracts which underpin long-term financing arrangements. If the US exporters succeed, and there is a long list of other LNG developments after Sabine Pass, then LNG could become as freely traded as oil, with a price that moves up and down as rapidly as oil.

10. All investment banks which have analysed the Woodside proposal to Oil Search doubt that it can succeed in its current form, and question why it has been made. Citi has downgraded its view of Oil Search because it believes the deal will lapse, taking Oil Search’s price back down from $7.90 to $6.42. Macquarie sees merit in the deal for Woodside but doubts the price is acceptable to Oil Search. Credit Suisse thinks Oil Search is a quality asset but also asks the tricky question of whether Woodside is worried about growth.

It is with all those factors percolating in the background that Woodside has launched its proposed acquisition of Oil Search.

In theory, the deal might proceed, but not on the current terms because there is so little in the proposal for Oil Search shareholders, especially the PNG Government.

In reality, the deal will either be dropped or it could trigger a shuffle in the ownership of PNG LNG by providing a mechanism for Santos to sell its 13.5 per cent stake in the project – but how that might work will be interesting to watch.