Santos rejects Harbour Energy's $14.4b takeover bid

Oil and gas company Santos has rejected the $14.4 billion takeover proposal from United States giant Harbour Energy and terminated all discussions with the group.

Santos said in a statement to the ASX on Tuesday evening that the final proposal from Harbour was a "highly leveraged private equity-backed structure" that prior to implementation would have required Santos to provide significant support for Harbour's debt raising and to hedge a significant proportion of oil-linked production.

The company said the proposal was also subject to various conditions, including Foreign Investment Review Board approval and restrictions on the conduct of the business of Santos from the time of entering into any scheme implementation deed. This "protracted execution timetable" delivered too much uncertainty to shareholders and exposed Santos to a high degree of risk.

"After careful consideration of all aspects of the final proposal, the Santos independent directors and managing director and CEO have unanimously resolved to reject the final proposal on the basis that it does not represent a full value of the company".

Santos chairman Keith Spence said the company was much better off pursuing its own strategies.

"Santos has a well-developed strategy, strong leadership and management team and outstanding growth opportunities that the board believes will deliver superior value for its shareholders over time," Mr Spence said.

Harbour Disappointed

Harbour Energy was annoyed on Tuesday night. "Harbour is disappointed in the Santos Board's decision to reject a fully funded offer with a compelling premium totalling approximately A$4.0 billion from an established, credible acquirer," a Harbour spokesman said.

"There was insufficient engagement with Santos on valuation, no meaningful attempt by Santos to discuss a realistic price which could be supported by any reasonable set of technical and commercial assumptions, and an unwillingness by their Board to explore means of closing the gap between the Offer and their expectations," the Harbour spokesman said.

Mr Spence also said the offer price was too low and the control premium was inadequate, and having a US-dollar based bid put too much foreign exchange risk onto the 120,000 retail shareholders in the company.

The Santos board said there had been a significant improvement in the company's operating performance over the past two years, and the company was expecting to reach its 2019 net debt reduction target of $2 billion more than a year ahead of schedule, based on current oil prices.

The Santos board was also unhappy with Harbour's "reliance on a very high level of debt funding" and what it said was unequal treatment of shareholders, where large shareholders were offered the opportunity to stay invested in the business. It was referring to Chinese shareholders ENN and Hony, who have a combined 15.1 per cent of Santos and had backed the latest Harbour proposal.

FIRB Issues

Earlier on Tuesday, analysts suggested Harbour could undertake sale-and-leaseback deals on crucial Santos infrastructure including the Moomba gas plant to improve its chances of gaining approval from the Foreign Investment Review Board for its $14.4 billion takeover offer.

Citi analyst James Byrne said important infrastructure assets, which also include the Port Bonython hydrocarbon processing plant that has been operating for almost 30 years near Whyalla, may be among those that FIRB "may take issue" with being foreign owned. A sell-off to an Australian infrastructure investor might have been pursued to help fix that problem.

A recommendation by the Santos board in favour of the bid would have been crucial for Harbour's chances of success because of the army of small retail shareholders on the Santos register. Santos has about 125,000 shareholders in total. If Harbour had gained FIRB approval, a meeting of shareholders would have needed to be held later in 2018 to vote on the bid, with more than 75 per cent needing to give it the green light at a shareholder meeting.

Santos shares gained 8¢ to $6.44 on Tuesday, up 1.3 per cent. But it was still well shy of the offer price, reflecting the doubts on whether Harbour would be able to secure FIRB approval. Santos shares were languishing at $2.90 in mid-July last year.

South Australian Premier Steven Marshall has emphasised on several occasions to Harbour chief executive Linda Cook in the past few weeks that the Santos headquarters staying in Adelaide is a non-negotiable and that job numbers in the state need to be expanded. It is the largest ASX-listed company in South Australia, even though its own head office workforce numbers have been culled substantially in the past two years by chief executive Kevin Gallagher as he aggressively cut costs.

A former South Australian federal Liberal MP, Patrick Secker, who was the MP for the seat of Barker for 15 years until 2013, is one of the six part-time members of the FIRB. Alice Williams, a director of ASX-listed Cooper Energy, which shifted its head office to Adelaide from Perth in 2013, is also on the FIRB board.

Citi's Mr Byrne said the Moomba gas processing plant and the Port Bonython terminal and pipeline were key infrastructure assets "that FIRB may take issue with being foreign owned".

But it could be managed by pursuing a sale-and-leaseback to a domestic infrastructure investor, "which not only removes this risk from a FIRB perspective, but also gives a potential sugar hit to Harbour's debt".

Sum of the Parts

Citi has a sum-of-the-parts valuation for Santos of $5.93 per share at an oil price of $US65 a barrel.

Harbour declared on Monday that its latest offer was its "best and final".

Harbour increased its offer for the South Australian oil and gas producer to $US5.21 ($6.95) a share, valuing the company at $14.4 billion, after having offered $US5.12 a share on Saturday.

The company said the revised proposal was conditional on Santos undertaking additional hedging of oil-linked production in 2018 of around 30 per cent, along with changes to hedging in 2019.

Harbour has also indicated the offer price would be increased to a US dollar amount equivalent to $7 a share if Santos agrees to hedge 30 per cent of oil-linked production in 2020.

The higher bid on Monday follows earlier, binding, conditional offers from Harbour of $US4.98 per share announced on May 17, 2018. It has increased its own offer four times in the past few months.

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