The Hides gas field, part of the PNG LNG project. The Oil Search/Santos merger would see the new merged entity acquire Oil Search’s 29 per cent interest in PNG LNG. Credit: Oil Search

Following Oil Search’s recent rejection of Santos’ previous merger offer, both companies this week released details of a revised offer for the merger of the two companies, which would see Oil Search shareholders owning approximately 38.5 per cent of a new merged entity, and Santos shareholders owning the remaining 61.5 per cent.

Under the revised offer, Oil Search shareholders would receive 0.6275 new Santos shares for each Oil Search share they currently hold, via a ‘scheme of arrangement’. This is an improvement on the previously rejected offer of 0.589 Santos shares.

Australia’s Santos suggests this values Oil Search shares at A$4.29 (K11.06) per share, based on the value of Oil Search shares on 19 July.

In a statement, Santos’ Managing Director and Chief Executive Officer Kevin Gallagher said a merger between Santos and PNG’s largest company ‘represents a compelling combination of two industry leaders to create an unrivalled regional champion of size and scale with a unique diversified portfolio of long-life, low-cost oil and gas assets.’

Approvals

Santos’ Kevin Gallagher.

As Oil Search has pointed out in its own release to the market, any merger agreement would ‘be subject to a number of conditions, including Oil Search shareholder approval, PNG court approval and regulatory approvals.’

It does, however, already have the support of Oil Search’s board.

‘Subject to each party completing due diligence on the other to its satisfaction, and entry into a merger implementation agreement, the Oil Search board intends to unanimously recommend that shareholders vote in favour of the Revised Proposal,’ said Oil Search’s statement.

However, it also added the addendum that this approval was ‘in the absence of a superior proposal and subject to the conclusion of an independent expert that the Revised Proposal is in the best interests of Oil Search shareholders.’

Compelling value

By merging with Oil Search, Santos would acquire Oil Search’s major assets: its 29 per cent interest in the productive ExxonMobil-led PNG LNG project and its 22.8 per cent interest in the Total-led Papua LNG project in Gulf Province, which is expected to go into front-end engineering and design (FEED) next year.

Santos claims the proposed merger would create a company with a ‘pro-forma market capitalisation of A$21 billion (K54 billion)’, placing it ‘in the top-20 ASX-listed companies and the 20 largest global oil and gas companies’.

‘Oil Search cautioned the market that “there is no certainty that the Revised Proposal will result in a transaction”.’

The merged company would have oil and gas assets across not just PNG, but also Australia, Timor-Leste and North America.

‘The combination would also create greater alignment in PNG supporting the development of key projects including Papua LNG, deliver new jobs and help support the local economy,’ said Santos’ statement.

Next steps

Both parties will now enter into a ‘best endeavours’ due diligence period, expected to take about four weeks, during which no third-party offers will be considered.

‘All of a sudden, PNG projects will be competing for capital with Australian projects in the Santos pool.’

Should due diligence proceed as intended, a final merger agreement would be executed between the two companies.

However, Oil Search cautioned investors that ‘there is no certainty that the Revised Proposal will result in a transaction’.

Implications for PNG

JMP Securities’ Lars Mortensen

The implications for Oil Search’s PNG-based employees and shareholders are not clear at this stage.

While Wood Mackenzie Research Director Andrew Harwood notes that a stronger balance sheet would provide ‘a solid platform from which to invest in new development projects in Australia and PNG,’ a merged entity is likely to seek to reduce its back office costs, which may mean some job losses in administration and management.

‘What we want to know is to what extent they are going to maintain a strong presence, both corporate and and technical, in-country. We don’t know that but we hope it’s going to be significant,’ says Lars Mortensen, Managing Director of PNG stockbroker JMP Securities, who is broadly positive about the deal.

He tells Business Advantage PNG that the merged entity may have a subtly different relationship to PNG from that of Oil Search.

‘Every opportunity on the Oil Search balance sheet was in PNG, therefore all of capital they deployed was in PNG. Therefore, the success of Oil Search was inextricably linked to delivering projects in PNG. Everyone will want to see if that going to continue to be the case.

‘We know that the combined entity will have a significant portion of its income derived from PNG. It will no doubt be ‘committed’ to PNG, but will it be going to be driving new projects and growth assets as hard as Oil Search did because it had not other options?

‘All of a sudden, PNG projects will be competing for capital with Australian projects in the Santos pool.’

PNG shareholders

It is also unclear at this stage if Santos intends listing on PNG’s stock exchange, the PNGX, where Oil Search has been listed since 2001.

Oil Search, which is also listed on the Australian Securities Exchange (ASX), has about 4800 PNG shareholders, around 14% of its total shareholder register. The largest of these is superannuation fund, Nasfund. If the deal goes through, they could find themselves shareholders in a company listed solely in Australia, with the PNGX losing an important local listing.

‘We would advocate the merits of Santos having a compliance listing in PNG,’ says Mortensen. ‘It makes sense to maintain the development of PNG’s capital markets but it would also be good for Santos.’

Positive reaction

The move is seen positively by most Australian analysts.

‘Overlapping interests in PNG, a strengthened financial platform and the potential for further portfolio synergies and optimisation provide strong strategic rationale for the merger,’ says Andrew Harwood.

‘Combining with Oil Search would immediately increase Santos’ production by over one-third, to around 290 kboe/d (kilobarrels of oil equivalent per day). The impact of Oil Search’s portfolio becomes more pronounced by the middle of the decade when it would contribute over half of growth to the combined production output.’

‘For us, Kevin Gallagher is one of the best CEOs in corporate Australia, so we’d love to see him managing the assets,’ Matt Haupt of Wilson Asset Management, a holder of both Santos and Oil Search shares, told the Australian Financial Review.

There is some speculation, however, that any merger may result in some asset sales.

UBS energy analyst Tom Allen is reported as suggesting the merged entity may consider selling part of its stake in PNG LNG and Oil Search’s Pikka project in Alaska. He observed that at least 40 per cent of the merged company’s pro forma gross earnings in 2020 were generated in PNG, ‘which could attract country concentration risk from ratings agencies.’