Ann: Santos rejects Harbour proposal and terminates discussions, page-139

Santos Limited (STO)
Update: Santos Standing on its Own Again as Harbour Shown the Door. FVE Down 6% to AUD 6.30
Recommendation: Hold
Change: No Change
No sooner has Harbour Energy's revised formalised AUD 7.00 bid been tabled and Santos gives it short shrift. Some may say it's a brave move, and a 10% decline in the shares upon announcement suggests it might be more than just some. But we think Santos' CEO Kevin Gallagher may just be the man to prove them wrong, particularly if recent form is anything to go by. He has remodelled Santos into a lean mean fighting machine, unencumbered by excess debt and master of its own destiny. Given rejection of the bid and its being final according to Harbour, we reduce our fair value estimate by 6% to our only recently upgraded AUD 6.30 stand-alone estimate. In the less likely event another bid should eventuate, that fair value still places us effectively to participate.

Santos' rejection pointed to the highly leveraged nature of the bid structure and its not representing full value as key elements in its thinking. It was not willing to lend support to Harbour's debt raising, including hedging a significant portion of oil-linked production, that would have limited upside to rising oil prices. These are all valid points.

If shareholders are to wear a lesser share price in the near term while Santos continues the work of ultimately realising AUD 7.00-plus in fair value, there are number of positives to ease the way. Santos expects to reach its 2019 net debt target of AUD 2.0 billion more than a year ahead of schedule at current oil prices. Our modelling has the target being met by early-2020. But if we use USD 80 per barrel Brent spot pricing instead, we get there before end-2019, and if sustained, that pricing supports an AUD 8.50 fair value estimate. Either way it lends confidence to our unchanged assumption for reinstatement of dividends from this year. We conservatively assume a 40% payout ratio which on our Brent forecasts for USD 70 in 2018 and USD 66.50 in 2019, and the current AUD 6.90 share price, translates to handy if not earth-shattering yields of 2.5% and 2.6%.