Ann: Presentation - Recommended Merger of Beach and Drillsearch, page-33

Drillsearch chairman Jim McKerlie has long been the reluctant bride. But he had a change of heart several months ago when the stars aligned for a long-touted tie up with oil and gas partner Beach Energy.

Despite Beach's advances and encouragement from the Stokes family, who own stakes in both companies, Drillsearch had previously been reluctant to play ball. But as the oil price fell to US$50 a barrel, McKerlie realised consolidation was inevitable.

While the synergy from combining the two companies are an obvious selling point, the real motivation was joining forces to take advantage of the cheap assets coming up for grabs in the distressed oil and gas market.

This was particularly attractive for Kerry Stokes' Seven Group Holdings, which did not formally broker the tie-up, but has made its feelings, that something happen sooner rather than later, well known to both sides.

Drillsearch had been running an internal programme called Project Domino, which was tasked at looking at strategic opportunities. The project name was based on the theory that at the first hint of consolidation in the Cooper Basin then the dominos would start falling.

The dominos have been falling in the wider oil and gas sector for months now. The $1.2 billion marriage between Drillsearch and Beach is just the latest in a string of deals, including this week's $7 billion approach for oil and gas giant Santos, which the target has rejected.

Drillsearch's Project Domino looked at a range of options, running the ruler over a string of potential acquisitions or selling assets in the Cooper Basin to Beach and other operators in the region, including Senex Energy.

At the same time, McKerlie was getting a clear message from shareholders in Asia, North America and the United Kingdom that the company's shrinking share price meant it was no longer a viable investment for them. Drillsearch has a lot of Asian shareholders who hold stock in the company as security for margin loans.

The declining oil price meant Drillsearch had gone from being an $800 million company to one with a market capitalisation of $300 million. This meant raising the funds to make significant acquisitions was also tricky.

NO MORE OPTIONS
The last straw was the realisation that the US$50 oil price environment was not going to change in the short term. With production maxing out, Drillsearch simply ran out of options to grow and take advantage of consolidation opportunities in a depressed environment.

Shortly after the sudden resignation of former Beach Energy chief Robert Cole, McKerlie contacted Beach chairman Glenn Davis to get serious about negotiating a deal. Both sides had already done their homework and the logic of getting the two Cooper Basin partners together was well known.

Getting Beach to pay the premium McKerlie believed was acceptable to his shareholders was the next challenge. The negotiations were understood to be tough and there were times when both sides threatened to walk away.

Davis will not going into detail, but says there were "lots of twists and turns".

"You can be assured the negotiations were conducted in a hard, but professional manner," he says.

The end result was the $1.2 billion deal announced Friday which will see Drillsearch shareholders receive 1.25 shares for every Beach share held. The deal, which values Drillsearch at around $380 million, is a 27 per cent premium to Drillsearch's closing price on Thursday.

The all-scrip deal means neither side have to fork out cash at the bottom of the cycle. While the $20 million in synergies from combining the two companies are part of the strategic rationale, the main prize is the potential for acquisitions by the combined entity at the bottom of the cycle.

The new Beach will be the largest mid-cap in the Cooper Basin with the firepower to go after the opportunities in a sector ravaged by the falling oil price. Beach is already in joint ventures with Santos and Oil Search, which have assets to sell after being caught short by the falling oil price. Beach is not ruling out asset sales to fund deals, and has about $300 million in cash on hand.

There are few companies left in the sector with the balance sheet strength to make acquisitions.

This is a key attraction for Kerry Stokes and son Ryan, who is chief executive of Seven Group Holdings. Seven had been quietly encouraging the two sides to get together, sensing an urgency given the number of distressed assets coming onto the market.

Seven will own just under 20 per cent of the combined group, giving it a seat at the table in terms of on-shore Australian oil and gas deals.

DEAL WELCOMED
Both Beach and Drillsearch say neither Kerry nor Ryan Stokes brokered the deal announced Friday, but it is safe to assume that Seven has been quietly encouraging the two companies to get together. Ryan Stokes on Friday said in a statement he welcomed the deal, which he says creates significant synergies and growth opportunities.

Kerry Stokes has a history of creeping up the share register of companies he takes stakes in, although the market has wised-up to that tactic. Seven now has the option of using Beach as a vehicle to do more in onshore Australian oil and gas. It also sees opportunities to play a greater role in the east coast gas story, as well as with what is happening in the region.

The most obvious target for the combined group is Santos's Cooper Basin assets, which are up for grabs as part of a wider asset sale process. Seven could be called upon to chip in if a combined Beach-Drillsearch did not have the funding to broker a deal that size. Beach is seen as a logical owner of those assets.

Few doubt the logic of the merger announced Friday. Beach and Drillsearch have overlapping permits in several areas of the Cooper Basin and are already partners in two key assets. The combined group with have production of 12.1 million barrels of oil and combined revenue of $978 million.

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