Australia | Sep 09 2015
-What does this signal for outlook?
-What about PNG government stake?
-Why not use cash instead of scrip?
By Eva Brocklehurst
How many questions can a takeover bid throw up? The answer is: plenty, particularly when it involves major players in an oil sector plagued by a weak pricing outlook.
Woodside Petroleum ((WPL)) has made an 1-for-4 scrip offer for Oil Search ((OSH)) with an effective price of around $7.65 based on the prior closing price of the stock. This implies a market cap of around $11.6bn.
The immediate reaction is: Oil Search shares are higher and Woodside lower. A deal would bolt on Oil Search's LNG assets in PNG and provide Woodside with a larger operation, as well as quality growth projects to pursue.
The low price of debt at present makes an all-scrip offer appear odd, in Credit Suisse's view. The broker also believes the offer only covers the base business and excludes Oil Search's interest in Elk-Antelope. The question is then posed: How to evaluate a bid at current implied oil prices versus existing opportunities? This reinforces Credit Suisse's suspicions that Woodside's Browse project will not proceed post FEED (Front End Engineering Decision).
While accepting Oil Search is a value play, in the absence of an oil price recovery, Credit Suisse has always found it hard to envisage what would make the stock outperform Woodside in the near term. Now there may be an answer but, in view of the reaction in the share price, a deal seems harder to realise.
Hence, the offer makes little sense to the broker. Around $10 a share would be needed to placate an Oil Search shareholder while, given the offer is already around 5.0% dilutive to Woodside earnings in 2016, it is puzzling to work out why the proposal would please its shareholders.
Deutsche Bank is also mystified, finding the strategy acceptable but the numbers hard to stack up. The broker believes the offer in the current form would be hard to achieve. The current oil price environment has meant share market valuations for growth assets ahead of final investment decisions being made have come under disproportionate pressure.
Deutsche Bank believes Oil Search investors require a more material premium – the offer represents around 13-14% – given it holds the lowest-cost LNG development opportunities globally.
Moreover, The PNG government holds a material 10% stake in Oil Search and its support would be required for success. The PNG takeover code also has a national interest test, effectively giving the government a deciding vote on whether a takeover takes place. Hence, Deutsche Bank does not envisage a situation where the bid would be successful, unless the government obtains a sufficient uplift on its $8.20/share investment.
While the rationale is to broaden the depth and quality of Woodside's growth options, in terms of valuation there is little merit for shareholders, in Deutsche Bank's view. The broker accepts potential suitors may line up for a counter-bid, such as Total, Petronas and Inpex.
ExxonMobil is the most obvious counter bidder, as it operates the PNG LNG project with a 33% stake and would be able to consolidate its interest. Its US dollar funding sources also put it at a competitive advantage versus Woodside.
Macquarie has fewer qualms. There is strategic merit for Woodside in terms of diversification away from the Carnarvon and Browse basins, where economics and resource additions are challenging. Still, support from Oil Search for a merger will come down to price. Regarding this offer, Macquarie believes the merger ratio implies a share price that is discounting the core oil business. The broker also believes potential counter bidders will be interested.
Shell, ExxonMobil and Total all showed interest in the recent sale process when InterOil sold down its stake in Elk-Antelope, with Total ultimately selected as the preferred partner. Macquarie suspects the scale and potential risks of the proposal reveal the headwinds Woodside faces in its portfolio. It will be other companies which are, ultimately, going to set the price.
Oil Search is likely to take a week to review the offer and then decline, in Citi's view. Woodside would then still market the deal to investors to measure interest before deciding on the next step. The broker believes chasing the acquisition becomes difficult, given Woodside has promised to be disciplined in acquisitions. In terms of a counter-offer, Citi has doubts. There would few operators able to gain the approval of the PNG government that are also able to buy assets of this scale.
On the other side of the coin, Woodside is now in the position of having the market assume the worst for its own growth outlook. Citi suggests the deal implies that Woodside's scrip is overvalued. Otherwise, why not use cash? The bigger issue now centres on the damage to perceptions that Woodside is a prudent operator and a safe pair of hands in terms of allocating capital. Citi downgrades both stocks on the news. Woodside to Neutral from Buy and Oil Search to Sell from Neutral.
FNArena's database reveals six Buy ratings for Oil Search, one Hold and one Sell (Citi). The consensus target is $8.10, suggesting 4.5% upside to the last share price. This compares with $7.89 ahead of the bid.
Woodside has one Buy rating (Credit Suisse), four Hold and three Sell. The consensus target is $32.89, suggesting 11.1% upside to the last share price. Woodside's dividend yield on present FX values for 2015 and 2016 is 5.3% and 5.6% respectively.
As a backdrop to this development, UBS has sharply lowered its oil price forecasts. Long-term oil price forecasts are reduced to US$80/barrel from US$90/bbl while in the near term, Brent forecasts for 2015/16 are reduced to US$55.00-57.50/bbl from US$61.50-70.00/bbl.
With large cap stocks generating most of their cash flow from LNG, and LNG prices linked to oil, a weaker oil price outlook has negative implications across the sector, UBS maintains. The broker's 2016 earnings forecasts for Woodside and Oil Search are reduced by 43% and 44% respectively.
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