Santos finds a more suitable Chinese partner

China’s ENN has emerged as the key strategic shareholder in Santos, bailing out the uber-rich backers of Hony Capital.

Santos gets more suitable partner

China’s ENN Group has emerged as the key strategic shareholder in Santos and, in the process, has bailed out the group of uber-rich backers of China’s largest private equity group, Hony Capital.

Hony emerged as a major shareholder in Santos (STO), somewhat controversially, after the oil and gas producer opted for a big equity raising last year after rejecting overtures and a potential takeover offer from another consortium of powerful and wealthy investors.

The controversial aspect was a $500 million placement to Hony, which also participated in the deeply-discounted rights issue and subsequently has purchased more shares on market to take its shareholding to 11.7 per cent at an overall cost of about $1 billion, or roughly $5 a share.

Santos is currently trading at below $4 a share. They closed yesterday at $3.95 a share and have traded as low as $2.44 this year when the oil price was plumbing its recent depths of less than $US30 a barrel. It is now just above $US40 a barrel.

Despite the improvement in the oil price, Hony (which counts the Bill and Melinda Gates Foundation, Goldman Sachs, Canada Pension Plan Investment Board and Singapore’s Temasek among its investors) was looking at paper losses of about $215m on the stake until ENN Group came along.

ENN, via its Shanghai-listed subsidiary ENN Ecological Holdings, has agreed to acquire the Santos shareholding for $US750m, or nearly $1bn. Hony will in turn subscribe to a private placement of, it appears, around 15 per cent of ENN-EC’s capital, paying about $US380m. ENN-EC has a market capitalisation approaching $US2bn.

Given that the Australian dollar has appreciated by about 7 per cent against the US dollar and 10 per cent against the yuan since Hony first appeared on the Santos register, Hony will probably get out about square on the four-month play. It could have been a lot worse.

Santos, which had to approve the transfer of the shareholding under the terms of the deal it struck when it made the placement to Hony last November, is probably pleased to have a private equity shareholder displaced by a trade buyer. It welcomed ENN, describing it as “a shareholder with obvious knowledge of the gas business across the region”.

Despite the change of ownership from Hony to ENN, the shareholding will continue to remain escrowed until 9 November this year.

ENN Group is one of China’s biggest natural gas distributors and it largest private gas group, with operations in nearly 150 cities, more than 11 million customers and a vast industrial and commercial customer base.

Earlier this month, it conditionally agreed a five-year deal with Origin Energy to take 500,000 tonnes of LNG a year that will form the foundations for what Origin hopes will evolve into a meaningful LNG trading business.

That deal and now the acquisition of the Santos stake fit within the early phase of ENN’s stated strategy of becoming vertically integrated, giving it exposures and access to gas further upstream.

It is building China’s first private LNG receiving terminal in Zhoushan, Zhejiang Province, which will have the capacity to handle three million tonnes of LNG when the first phase is completed in 2018.

It therefore looks a more natural cornerstone and long-term shareholder for Santos than Hony and one that could conceivably add value as a customer and/or listening post in China for Santos and for LNG from Santos’ interests in two of the bigger LNG facilities in the region. Santos leads the GLNG consortium that is producing LNG at Gladstone in Queensland and has interests in the PNG LNG project in Papua New Guinea and Darwin LNG in the Northern Territory.

While ENN is paying about $1 a share over market for the Santos shareholding, that could be attributed to the size of the stake and its strategic value. Santos is obviously heavily financially and operationally leveraged to oil and gas prices, so there is longer term upside for ENN within the kinds of time horizons it would have to use to plan for its own businesses. An exposure to Santos also provides a form of natural hedge for ENN as a buyer of LNG.

If prices are low — as they are likely to be for the rest of this decade because of a glut of supply as a number of big new LNG plants have come into the market — it benefits as a customer.

If prices subsequently rise sharply because the plunge in oil prices has truncated the pipeline of new projects — as we saw yesterday with the Woodside announcement that it wouldn’t proceed with the development of the $40bn or so Browse floating LNG project off Western Australia — it would be able to blunt the impact via its exposure to Santos.

The oil and gas sector’s own projections for long-term demand for LNG show it rising steadily and gaining share in the overall energy market, with demand particularly strong in the Asia Pacific region.

Hony’s private equity investors were unlikely to have the patience or investment time horizons to wait until the next decade for a pay-off on the high-risk investment they made in Santos last year. The nature of ENN, and the construction of that import terminal, means it probably will be thinking about 2020 and well beyond.