Brokers Back Drillsearch And Beach Merger

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-Maximises scale, assets, cost synergies
-Support from major shareholder
-Little risk of rejection
 

By Eva Brocklehurst

The union of Drillsearch Energy ((DLS)) and Beach Energy ((BPT)) has been welcomed, and indeed pre-empted, by a number of brokers. The merger will be conducted in the form of a takeover by Beach. Beach Energy will offer 1.25 shares for each Drillsearch share. Drillsearch will own 30% of the merged entity.

This merger had to happen, in Credit Suisse's view. A company will be formed which will offer scale, upside and a portfolio of both producing and growth assets, which is considered a rarity in the sector these days. Beach will conduct a search for a CEO to lead the new company and Drillsearch will have two seats on the board (its chairman and a director), replacing two Beach Energy directors.

Forecast synergies, initially estimated at $20m, are far too modest, Credit Suisse maintains. Drillsearch operates no producing assets and over 90% of its FY15 production was in joint venture with Beach. Anything less than $30m of costs being removed would represent a failure, in the broker's opinion.

On current estimates the combined entity would have a 10-year reserve life. What makes the deal so compelling for brokers is that it comes at a time when the large cap players are engaged in their own mix of issues. The transaction is on heels of the indicative and conditional bids for Santos ((STO)) from Scepter Group and for Oil Search ((OSH)) from Woodside Petroleum ((WPL)).

For Credit Suisse, while the merger is not materially accretive to Beach at face value it provides more options and opportunity to crystallise value.

The merged entity would have pro-forma market capitalisation of $1.17bn, with FY16 production of 10.6-11.8mmboe, cash of $302m and debt of $311m. The company would also own 100% of a number of oil and gas blocks on the Western Flank of the Cooper Basin.

UBS notes Seven Group ((SVW)), which has a 19.9% stake in both companies, has supported the merger. Drillsearch shareholders are expected to vote on the scheme in late January and, if approved, it should be implemented in February.

Morgan Stanley outlines the reasons it should benefit both companies. These lie with greater scale, operation and cost synergies, a stronger balance sheet and opportunities to high-grade exploration from a consolidated acreage.

The broker considers the group's position in the Cooper Basin may provide a unique opportunity in the future. It contains gas infrastructure, including storage, and longer term there is also shale and tight gas potential.

One aspect that remains unchanged by the merger is the dependence on the highly productive but short life at the Western Flank, the broker contends. There are cost benefits from greater scale but the issue is more about managing the decline.

Over time, Morgan Stanley expects Beach to use its expanded capital base and pursue other acquisitions, noting both Origin Energy ((ORG)) and Santos ((STO)) have assets up for sale.

The deal implies a takeover premium of 28% for Drillsearch which, given such premia have ranged between 20-50%, makes it fairly undemanding in Deutsche Bank's view. Is it sufficient compensation for Drillsearch shareholders?

Drillsearch shareholders will have reduced leverage to the Western Flank which the broker considers is the main attraction in its investment thesis. On Deutsche Bank's numbers, Drillsearch shareholders are only realising a 13% change-of-control premium.

Still, the broker suspects there is little risk that the arrangement will be rejected. As Seven Group supports the move, and many others with holdings in both camps are also likely to be supportive, the change of control premium is not a major issue.

FNArena's database has two Buy ratings and two Hold for Drillsearch with a consensus target of 85c, suggesting 4.6% upside to the last share price. Targets range from 70c (Credit Suisse) to 95c (Deutsche Bank and Morgan Stanley). Beach has three Buy and two Hold ratings. The consensus target is 84c, signalling 21.7% upside to the last share price. Targets range from 65c (UBS) to $1.09 (Morgan Stanley).
 

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