Looking into the Woodside and Santos merger

Company News

by Peter Milios

Woodside Energy (ASX:WDS) and Santos (ASX:STO) have officially confirmed media reports that both companies are engaged in preliminary discussions regarding a possible merger. While it's important to note that these discussions are in their early stages and may not necessarily lead to a merger, the potential combination of these energy giants, with a combined market capitalisation of approximately A$80 billion, has significant implications for the Asia-Pacific liquefied natural gas (LNG) sector and the broader energy industry.

Merger Scenarios and Rationale

Assuming an all-scrip merger and a 20% to 30% premium to STO's closing share price on December 7, 2023 (valuing STO shares at A$8.20 to A$8.88 per share), analysts estimate that STO shareholders might receive 0.273 to 0.296 WDS shares per STO share held. This potential merger could create a major APAC LNG company with a diversified asset base and a product mix heavily focused on LNG and natural gas, accounting for over 70% of its production.

Indicative Synergies, EPS, and FCF Accretion

The estimated synergies resulting from this merger are projected to range from $150 million to $300 million, with a base case assumption of $200 million. These synergies are expected to be derived from various sources, including reductions in corporate costs, exploration capital expenditure, cost-of-debt savings, and trading synergies stemming from the enlarged portfolio.

Under this framework, the merger is estimated to be EPS accretive from year one, which is a positive development for WDS shareholders, who have experienced a series of consensus downgrades to dividends per share in recent months. Due to STO's higher relative capital expenditure over the next three years, the merger is projected to become FCF per share accretive from 2027 onwards.

Key Risks and Timeline

Several key risks surround the potential merger, including the possibility of shareholders rejecting the proposed value split, concerns about the valuation of certain non-core assets, and regulatory hurdles from the Australian Competition and Consumer Commission (ACCC) regarding the concentration of East coast domestic gas supply. If divestments are required, the pool of potential buyers and market valuation may also impact the merger's economics.

An indicative timeline for the merger process suggests that approximately six weeks of due diligence could commence shortly, followed by the signing of a Binding Merger Implementation Deed by the end of January 2024. Subsequently, an ACCC review process is anticipated to occur between March and May 2024.

Relative Value and Future Prospects

Analysts value WDS at A$33.50 per share and STO at A$9.00 per share, both trading at implied oil prices of $65 and $58 per barrel, respectively. Despite the significant discount of STO's implied oil price, both companies are trading at 4.1-4.2 times their 2024 enterprise value to earnings before interest, taxes, depreciation, and amortization (EV/EBITDA). This underscores the potential value in STO's portfolio that may not be fully reflected in its stock price.

The success of the merger ultimately hinges on whether WDS is willing to recognise and pay for the value within STO's assets. This valuation gap represents a significant challenge that could impact the merger's progress.

In conclusion, the early-stage discussions between Woodside Energy and Santos Limited regarding a potential merger have sparked considerable interest in the energy sector. While the merger remains uncertain, it has the potential to reshape the APAC LNG market and create a formidable player in the global energy landscape. The coming months will be critical as both companies navigate the complexities of valuation, regulatory approvals, and shareholder sentiment.

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