PNG's national interest will decide Oil Search deal
Woodside's woefully inadequate offer for Oil Search will serve a useful political purpose by giving the aggressor an opportunity to pitch directly to the man who will make or break the deal, Papua New Guinea's Prime Minister, Peter O'Neill.
O'Neill will have two key considerations before giving his stamp of approval to any merger agreement: the national interest and the commercial considerations.
In considering PNG's national interest, O'Neill will be influenced by the same sort of arguments which persuaded former treasurer Peter Costello to reject the Shell takeover of Woodside in 2001.
In that case, Costello was concerned that Shell would not promote exports of LNG from the North West Shelf "in all circumstances in preference to all competing supplies".
The government's legitimate worry was that Shell would favour its gas interests in Malaysia, Brunei, Oman and Russia instead of expanding its interests in Western Australia. The North West Shelf project partners, including Woodside, later went ahead with a $US15 billion expansion of the Pluto LNG plant at Karratha.
It is now Woodside's turn to convince O'Neill that its ownership of Oil Search will bring advantages to the country that would not otherwise occur under existing arrangements.
That will be a challenge for Woodside chairman Michael Chaney and chief executive Peter Coleman for two reasons.
First, Oil Search is regarded by O'Neill as PNG's only successful national champion. He has invested a considerable amount of his own credibility in Oil Search being a long-term success.
His decision last year to approve the purchase of a 10 per cent stake in the company funded by a $1.2 billion loan from UBS was highly controversial. It led to the sacking of the then treasurer, Don Poyle, who refused to sign the UBS loan arrangement.
The PNG government investment in Oil Search is a tribute to the negotiating skills of Oil Search chief executive Peter Botten and his advisers, UBS.
In one fell swoop, Botten bound up the company's commercial interests with O'Neill's ambitions for the long-term economic development of PNG.
The Prime Minister will be reluctant to approve a merger that involves him swapping a 10 per cent holding in a company based in PNG operating under PNG law for a 3 per cent stake in an Australian company based in Perth with a diverse array of other interests.
Chaney and Coleman will have to come up with compelling arguments as to why PNG will be better off aligning itself with Woodside.
The second reason why Woodside will find it challenging to convince O'Neill of Woodside's worth to PNG is that its potential contribution to economic development will be measured against two global oil and gas giants, Total and Exxon.
These two gorillas of the LNG industry are already well entrenched in PNG. Exxon partnered with Oil Search in the PNG LNG project and Total is partnering with Oil Search in the $US20 billion Elk-Antelope development.
Exxon and Total bring world class technical engineering skills and financial strength to the task of extending the expansion of PNG's natural resources.
The second criteria that must be considered by O'Neill is the commercial consideration involved in Woodside's offer.
This is a tricky topic thanks to the complex deal that stands behind last year's purchase of PNG's 10 per cent stake in Oil Search.
When UBS lent PNG the $1.2 billion to buy the stock, it put in place a collar derivative arrangement to protect PNG against any downside in the share price as well as capping any upside.
The price paid for the stock was $8.20, which is well above the effective price of $7.64 a share inherent in the 1-for-4 scrip offer.
UBS has never revealed the details of the various strike prices associated with the collar derivative transaction and it never will. Without that information, it is difficult to know whether the PNG government is sitting on a loss on its investment in Oil Search.
UBS has maintained ownership of the stock as security for the loan to the PNG government.
The offer price is said by Woodside to be at a 23 per cent premium to the three-month-volume weighted average price before the deal was leaked in Street Talk.
While that premium has a semblance of merit at a time of low oil prices, it does not appear to capture the strategic value of the Oil Search assets.
Some of the peculiarities of the deal were highlighted by Credit Suisse analyst Mark Samter in a note to clients on Tuesday. He said the scrip offer was confusing given Woodside's low cost of debt and the valuation appeared to ignore the value of Elk Antelope development.
Samter, who is famous for his correct call on Santos needing to fix its balance sheet, says a deal would need to be far closer to $10 to get over the line. Another analyst, Nik Burns at UBS, said the premium being offered was only 13.5 per cent when compared with the prior closing price of $6.73 a share.
Burns said: "We don't see Oil Search accepting an offer at this level, given the quality of its growth portfolio and value potential."
Woodside is sitting on about $3.2billion in cash and can therefore afford to include a cash component with any offer. Both ratings agencies, Moody's Investors Service and Standard & Poor's, noted the improved cash flow benefits for Woodside from completing a merger. S&P was worried about the high level of country risk.
The deal sets up an interesting tussle between some leading investment banks.
Merrill Lynch and Gresham are advising Woodside while Morgan Stanley is advising Oil Search. The National Petroleum Company PNG is being advised by UBS. That advice will surely find its way to O'Neill.
Read more: http://www.afr.com/brand/chanticleer/pngs-national-interest-will-decide-oil-search-deal-20150908-gjhwi2#ixzz3lQE6Hyu6
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