Australia | Jun 18 2014
– Shell to reduce Woodside stake to 4.5%
– Instos may not be happy with exclusive Woodside buyback
– Dividend yield enhanced by the deal
– Growth prospects still an issue
By Greg Peel
In 2001, a takeover bid for Woodside Petroleum ((WPL)) by Royal Dutch Shell was blocked by then treasurer Peter Costello on national interest grounds. Neither company was happy, but Costello was under considerable political pressure not to let another major Australian corporation slip into foreign hands. Shell was left stuck with around one third of Woodside and a lack of control.
It was not until 2010 that Shell decided to reduce its Woodside stake, deciding no Australian government would ever allow a full takeover. It sold a 10% tranche to foreign and local institutions in what was then the biggest corporate sale in Australian history. Shell had explored, but later abandoned, an option of a joint takeover with BHP Billiton in order to overcome the “foreign” issue. The 10% sale sparked frenzied market speculation that BHP might make a move on Woodside alone, but this was never to be.
In 2010, Shell was concentrating on developing the huge Gorgon LNG project, and had decided this offered greater return potential than Woodside’s Pluto LNG project. In retrospect this was a reasonable move. Pluto came on line in 2012 and Gorgon is not due to come on line until next year, but Pluto was beset with delays, cost overruns, and a lack of gas sources that to date have restricted the project to only one LNG train.
Shell declared its remaining Woodside stake “non-core”, and as such that stake has hung over Woodside shares like an ominous cloud ever since.
Until yesterday.
Yesterday Shell announced a sale of 78.3m or 9.5% of Woodside shares at $41.35 in an underwritten placement, and Woodside announced it would purchase 78.3m from Shell via a selective buyback at $36.49. The institutional sale price represents a 3.5% discount to the previous close, while the buyback price represents a 14% discount to a five-day volume-weighted average price (VWAP). Shell is left with 4.5% of Woodside, below the 5% reporting threshold, meaning it can sell the balance without announcement at any time once the escrow period has expired.
The 10% stake Shell sold to institutions in 2010 represented a 7.9% discount.
The obvious question that jumps out here is: if the sale of the insto tranche is fully underwritten at $41.35, why would Shell agree to sell the other half to Woodside at a much lower $36.49? The answer lies in the dividend component, which is fully franked. The buyback releases otherwise stranded franking credits to Shell (which despite being foreign, pays tax on its Australian income) which when taken into consideration implies a true sale price of $48.50. So Woodside gets a 14% VWAP discount on purchase, and Shell effectively gets a 14% VWAP premium on sale. Who pays the difference? You and I do, via the ATO.
This does not, nevertheless, mean the instos are happy. Why cannot they, too, participate in the buyback and thus cash in on the franking credits?
Because then the deal is not as sweet for Shell, and if the response is the sale of only smaller tranche, Woodside remains stuck with an overhang and a proportion of franking credits which remain stranded. The deal is thus beneficial to both Shell and Woodside, and as far as brokers are concerned, instos should admit they have done about as well as they can do. If nothing else, the removal of the ominous cloud allows for greater potential share price upside from here.
Given Woodside offers little in the way of growth and is really only a yield stock at present, that upside is limited, but any upside in the oil price (See: Iraq) will still translate in upside for Woodside shares.
Nonetheless, the deal must achieve 75% shareholder approval to proceed. There is a risk some instos will block in favour of participation in the buyback, but JP Morgan, for one, considers rejection unlikely given at least half of Australia’s super funds would have to vote against the deal.
So assuming the deal goes ahead, where does this leave Woodside?
On first glance, shareholders might note that the $2.7bn Woodside will spend buying back its shares is $2.7bn that might otherwise have been paid out as a special dividend. At the very least, Shell will not now participate in the interim dividend and that cash will be distributed to shareholders. But the trade-off is that the buyback is around 6-8% accretive to earnings per share and thus by default, accretive to dividends per share. On Macquarie’s forecasts, Woodside’s 2015 yield of 7.2% becomes 7.7%.
A lump of franking credits is lost to Shell, but Woodside is amassing more credits on a daily basis.
And then there’s the overhang, which is now gone.
So in the wash-up it looks like a good deal all round. But this does not detract from the fact Woodside offers very little in the way of growth prospects. Today’s yield may look extremely attractive but without growth, that yield cannot be maintained into the future. While no one was unhappy when Woodside finally withdrew from what was becoming an increasingly tenuous Leviathan project, Leviathan still offered around 25% earnings per share growth by 2020, on Macquarie’s calculation, while the buyback offers only 6-8% EPS accretion.
Outside of Leviathan, Woodside faces around a 25% organic production growth decline to 2020, Credit Suisse points out. Despite the rationale of the buyback from Shell, the loss of $2.7bn of capital “makes the operational challenge harder still”. Woodside’s only growth project at present is Browse FLNG, and the fact that Shell should reduce its exposure to Browse only 12 months out from final investment decision (FID) “points to limited conviction,” suggests Macquarie.
(Browse stakeholders include both Woodside and Shell, with Shell’s stake boosted via its own stake in Woodside, until now.)
On the other hand, Credit Suisse is left wondering whether the 4.5% Woodside stake Shell is hanging on to could be used to fund an increased stake in Browse at some stage, “most importantly to give them operatorship”. The current operator-to-be is Woodside, and ironically back in 2001 Woodside welcomed Shell’s stake as it brought with it the skills, knowledge and systems Woodside was lacking. Those days are now long gone, notes Deutsche Bank, and Woodside is a capable operator in its own right.
The final outcome of the Shell sale to consider is that now that the overhang is gone, or at least analysts assume it will be after a positive vote, Woodside again becomes a takeover target. BHP has had its opportunities in the past and is not in acquisition mode presently, so maybe another foreigner?
What would today’s treasurer do?
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