Harbour Energy’s long and winding road to a promising Santos bid

When Harbour Energy knocked on Santos’s door eight months ago, it didn’t know a $1.3 billion impairment was coming.

Harbour Energy boss Linda Cook

When Linda Cook and her privately owned US firm Harbour Energy first knocked on the Santos door eight months ago with a takeover plan to build a new international LNG company, she didn’t know its board was about to tell the market it was booking a $1.3 billion impairment because of a worsening oil price outlook.

Despite this, the Santos board, still under the control of long-time chairman Peter Coates — gave the $8.1bn bid, at $4.55 a share and a 38 per cent premium to the then price, short shrift. It later said it undervalued the company to such an extent it did not feel the need to tell the market about the August 14 approach.

The knock-back proved the right decision, as has clearly been shown by last Tuesday’s Harbour approach at $6.50, valuing the company at $13.5bn and with which Santos has finally engaged with under new chairman Keith Spence.

“You have to give the Santos board credit for doing a great job, because they’ve created a lot of value for their shareholders by forcing us to be a bit more patient and come back at the time when the conditions were more conducive for a higher offer,” Ms Cook, a former Shell gas and power chief, told The Weekend Australian.

Harbour was reportedly set to come back with a $5.30 per share offer in November, when media reports forced the company to reveal the August approach. Harbour then took a four-month break before bombarding Santos with three offers in a week, at $6.25 a share, then $6.37 and finally, on March 29, the $6.50 offer that led Santos to open its books.

“It’s like trying to thread a needle, making an offer that makes compelling sense for existing shareholders but at the same time is a compelling prospect for your new investors, and that’s where we are today,” Ms Cook said.

For Harbour, a rising oil price since August and success in Santos chief executive Kevin Gallagher’s cost-cutting push, which has the company free cashflow-positive at an oil price of $US36 a barrel, meant it was able to come back with its higher bid.

“Our (August) offer may not have been reflective of how much we could have paid at the time,” Ms Cook said when asked how Harbour was able to come back with an offer at a 43 per cent premium to its original approach.

“But the outlook for oil prices in the near term is materially different to how it was in August and Santos has made continued progress with respect to cost reductions, drilling efficiency and other things, and has created a lot of value by doing that.”

The $1.3bn impairment Santos flagged to the market the day after the Harbour approach looked like bad news.

But it actually shows that the Santos team had seen the light at the end of a long tunnel and gives insight into why Mr Coates, Mr Gallagher and the rest of the board dismissed the $4.50 offer.

This is because limiting the impairment, which was on a negative oil price outlook the market had already factored in, was a $US330m after-tax write-back on increased productivity in the onshore Cooper Basin in South ­Australia.

Mr Gallagher says Santos’s outlook in the oil price did not change in the seven months between bids. But evidence of a turnaround strategy he had been pursuing since becoming Santos chief in February 2016 became much more evident.

Between the impairment announcement and the end of the year, Santos shares rose 63 per cent. “I take a lot of pride in the job we’ve all done here at Santos,” Mr Gallagher told The Weekend Australian.

“If somebody wants to own that vision and strategy, we feel they should pay for that.”

He stressed it is not a done deal.

“This is just an announcement that we are engaging with Harbour to see if we can develop the proposal to a point where the board can recommend it to shareholders,” Mr Gallagher said.

“There are a few conditions we need to work through and things we need to understand before we can do that.”

But at least the value has finally been agreed on.

As well as cutting group-wide cost, Mr Gallagher has simplified the company by organising a disparate collection into five core assets and started efforts to sell or improve non-core assets that made up relatively little of the company’s value.

The Gallagher turnaround was needed after a debt-heavy Santos buckled under low oil prices in 2014 and 2015, resulting in a $2.5bn equity raising to pay down debt it had taken on to finance its multi-billion-dollar investments in the Gladstone LNG project and Papua New Guinea LNG.

While Mr Gallagher’s turnaround and simplification has driven the value, it is the transformation into an export-focused company under the often maligned chairman/chief executive pairing of Mr Coates and David Knox that originally attracted Harbour.

That said, the overextension of the Adelaide company in building that model with debt and third-party domestic gas also provided the value for Harbour.

“Santos has been on the Harbour radar screen for about three years,” Ms Cook said.

“We had a look some time ago and didn’t feel the time was right, but we kept our model up to date because of our focus on wanting to identify the right platform for the Harbour business in Australia, Asia and global LNG.”

Hurdles to the deal include Foreign Investment Review Board approval and sealing a condition that between 15 per cent and 20 per cent of the existing register rolls over to an unlisted, Harbour-owned Santos.

Uncertainty over how this will play out has kept shares, which closed at $5.88 yesterday, up 3c but below the offer price.

To assist in convincing FIRB and the Treasurer at a time when there is intense political focus on the role of Santos in the east coast’s tight gas markets and surging prices, Harbour says it has no plans to move the company’s Adelaide headquarters and plans to invest more than Santos is now in producing domestic gas.