The seeds that grew into Harbour Energy's scuppered $14.4 billion bid for Santos were sown as far back as late 2016 by the South Australian gas company's then chairman, Peter Coates.
While his inspiration is disputed, Coates met repeatedly with a former bidder for Santos, Scepter Partners, to assess whether the spurned investor of royal capital retained any interest in re-engagement on a bid for the rapidly recovering driller.
It is understood that Coates, with investment banker John Wylie, in tow, met with the Scepter executive and at least one of its royal principals on at least three occasions through the first half of 2017.
Sources have told AFR Weekend that Scepter's operatives felt encouraged by the recovered dialogue with the chairman but knew that it would need help to finance what had to be a bigger price than its opening offer and to deliver a transaction with a more transparent governance framework.
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Harbour Energy's Linda Cook, a former aspirant for the top job at oil super-major Shell, was known to have designs on building a global gas trading house modelled on BG Group daniel.gray
As a result, Scepter approached Harbour Energy and its principal, Linda Cook, to discuss whether or not the acquisitive oil and gas private equity fund would be interested in leading a takeover bid.
Cook, a former aspirant for the top job at oil super-major Shell, was known to have designs on building a global gas trading house modelled on BG Group, which was taken over by her former employer in 2016 for $US70 billion ($92.7 billion). Cook seized her moment. Well, very nearly. Hope wins
Successful takeovers are essentially victories of relentless logic over sustaining hope. On May 22, after six months of private and public engagement with Harbour Energy, the Santos board – which includes two executive directors – formally shut down takeover negotiations with Harbour. Hope won the day.
Santos rejected the complication and risk of working to the point of sale and announced that the offer of up to $7 a share was not enough anyway. In the end, the board put greater store on promise than ratiocination.
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On May 22, after six months of private and public engagement with Harbour Energy, the Santos board – which includes two executive directors – formally shut down takeover negotiations with Harbour. Ben Searcy
There has been considerable speculation about the boardroom process that concluded with rejection. Last week, in revealing Scepter's funding support of the Harbour bid,The Australian Financial Review (well, me actually) reported that advisers Deutsche Bank and Rothschild had recommended acceptance of the bid. In a rare step onto the public record about his clients, a "pretty grumpy" Deutsche's Alex Cartel, said this claim was incorrect. "I can categorically say we did not recommend the offer," Cartel said adding that such claims were a stain on his reputation.
As it turns out the investment banks were not there to recommend anything. Their brief was to generate contemporaneous valuation and risk modelling, a task made ever more complicated through the public phase of the bid because of the volatility of oil prices.
Ahead of the conclusive board meeting of Tuesday May 22 the bankers were also asked to assess how real the offer actually was, how final its latest iteration might be and whether or not the nuances of the oil price hedging that Harbour now required to secured the bid was a risk too far. Cartel and his contemporary at Rothschild, Marshall Baillieu, presented their view and left the room.
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Harbour's bid put a price of about $US80 a barrel on the Santos book of proven and probable resource. David Mariuz
Some argue that the rejection that followed means Santos has taken a naked put option on the oil price and on management's ability to find and deliver more gas.
Harbour's bid put a price of about $US80 a barrel on the Santos book of proven and probable resource. The only thing really certain about the probable component of that resources base is that it will never be fully recovered.
So, if Santos builds its resource base and the oil price hits $US100, then Santos chairman Keith Spence will be deified as a champion of his retail owners. And if it falls to $US50 a barrel, his reputation will be trashed.
Not surprisingly, Santos chief executive Kevin Gallagher reckons this an excessively simplistic view.
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"The Harbour offer was never really $7 and was not a clean offer," Santos chief executive Kevin Gallagher said on Friday. David Rowe
"The Harbour offer was never really $7 and was not a clean offer," he said on Friday. "It required Santos to hedge a large amount of production now for a deal that was subject to completion and approvals risk. Had the deal failed, Santos shareholders could have been materially worse off. There was full engagement with Harbour – they bid six times, conditionally, but were unable to step up and provide a firm offer that could be recommended to Santos shareholders.
"It is very hard for anybody to value a company like ours," Gallagher continued. "Lots of people came to me through my first six months at Santos when I was working through what the strategy needed to be. They came to ask me whether I was prepared to sell the Cooper business. At that point, I would have been tempted. I said to most folks, give me six months until I work out what the Cooper Basin is for me.
"In most of those cases, the people making those approaches understood what was in the ground and quite frankly thought they could operate it more efficiently and better than Santos had done and was doing. They were probably right. But in two years we have turned that around, we are now growing production and uncovering prospects across the Basin because we are spending time and money getting to know the rocks again."
The rehabilitation of Santos' Cooper legacy sits the emblematic bedrock of the narrative of Harbour's rejection.
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The rehabilitation of Santos' Cooper legacy sits the emblematic bedrock of the narrative of Harbour's rejection.Brendan Esposito
The story runs like this: Santos is now the low-cost onshore driller in Australia. So the cost of getting Cooper gas out of the ground is no longer the inhibitor of growth that it once was. Santos will produce more gas from the Cooper in 2018 than it did last year and it is producing oil at a run-rate that should see production recover to 2008 levels.
Cooper oil is sweet stuff. It attracts a healthy premium over the traded oil benchmark, Brent crude.
Santos is now cash flow positive at a $US40 a barrel oil price. Gallagher says the business will throw off $US1 billion in free cash this year. Every extra $US10 a barrel of oil averaged over a year adds $US250 million to that cash flow base. This, says Gallagher, is the virtuous cycle triggered by lower costs, higher prices and swelling cash flows.
Santos has a slate of growth options that include grabbing a heavier weight of returns from Darwin LNG by back-filling it with gas supply, entering the mainstream of the rich PNG LNG business, defining just how rich and liquid (as in oily) the Northern Territory shale story is going to be, rebuilding the Cooper and growing the Queensland coal seam business to a point that the Santos operated Gladstone LNG project is self-sustaining, and developing the coal seams in NSW. And Gallagher says all of those can be funded out of future free cash flows.
Gallagher is said to have presented this outlook and a good deal more to the board on May 22. And, as a result, the horde of charming and sophisticated private equity barbarians were sent on their way having invested an estimated $30 million in the bid that never quite happened.
But, as high as it is, the loss of financial and intellectual investment in Santos was not the primary reason for the rejection.
Discretion and dispassion are core values in the private equity game. But the thick veneer of discipline was fractured by the full stop delivered by the Santos board late on Tuesday May 22. Harbour was stunned by its loss. Management was left bewildered. Harbour had bid against itself at least three times in response to Spence's entreaties.
On the Friday before rejection, Cook left a face-to-face meeting with Spence and his chief executive believing the stars of acceptance had aligned.
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Keith Spence David Mariuz
Instead, Team Harbour's people left the deal that never quite happened feeling they had been conned.
In confirming that he maintained a diplomatic dialogue with Scepter ahead of its second bite at Santos, former chairman Coates said it would be wrong to characterise his engagement as an invitation. He assessed the discussions as appropriate back-channel investigation of the potential of an offer that was motivated purely by his responsibility to maximise shareholder value.
Coates said Scepter invited him to a new round of confidential dialogue. Others say that it was Santos that initiated re-engagement. But, given Santos consistently introduced its engagement with Harbour as "unsolicited", we have to be necessarily sceptical about that claim.
Either way, insiders say the Santos pairing met with Scepter's fascinating founder and executive chairman Rayo Withanage and, at least once, with the prince from Brunei who helped him establish the business, Prince Abdul Ali Yil Kabier.
Withanage is an exotically successful eclectic who most recently made a bit of a splash in paying $33 million for a French Riviera house where Picasso spent his final 15 years on earth. He lists his hobbies as martial arts, polo, sailing and aviation and describes himself with joyful immodesty as an "accomplished jazz vocalist".
Withanage was born in Fiji to parents of Sri Lankan and Portuguese extraction. He grew up in Bermuda and was educated in Auckland and London before reportedly finding success as a mergers and acquisitions lawyer and then, eventually, as a manager of the wealth of sovereigns from Brunei, Asia and the Middle East.
Scepter was established in 2015 and is said to have $US15 billion in funds under management. It investment model is to syndicate opportunities through royal families and it is managed by a team recruited from private equity emperors, Blackstone.
It can be no coincidence that Scepter was introduced to Santos by the former senior managing director of Blackstone's Hong Kong office, the Melbourne-born Anthony Steains.
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Coates, whose second coming as chairman had been scarred by the urgent need to replace his chief executive, David Knox, was forced briefly into the breach left exposed by the departure of the affable but ill-starred Scotsman. David Mariuz
Coates was first introduced to Scepter back in October 2015 when the company approached Santos with a $7.14 billion takeover.
Scepter's timing was brutal.
Coates, whose second coming as chairman had been scarred by the urgent need to replace his chief executive, David Knox, was forced briefly into the breach left exposed by the departure of the affable but ill-starred Scotsman.
The August 2015 confirmation of Knox's "succession plan" arrived with the necessity of an "all options" review of the business that aimed "to restore and maximise shareholder value". Coates was prepared to contemplate any option to refloat a Santos balance sheet.
The troubles were threefold but compounding. Oil prices had more than halved from their $US100 a barrel norms, crushing Santos' free cash flow just as the company was nearing the end of the heavy capital lifting needed to finance its 30 per cent share of an $US18.5 billion liquid natural gas (GLNG) plant at Gladstone in Queensland. Knox's fate was sealed with GLNG nearing first production from the first of its trains. But the cash flow constraints meant that Santos had to slow down it coal seam gas drilling program and that risked the GLNG joint venture being left undersupplied.
The future saw that risk unfold into unhappy reality with the east coast gas market being left short of gas, in part, because Santos turned to third-party suppliers to feed its machine.
For all of that crisis, the Scepter bid arrived and went at pretty much the midpoint of that review. Coates and his board dismissed Scepter as opportunistic and its offer price as unreflective of fair value. At the time it seemed like the best thing to emerge from this brief dalliance was a moment of genius by the Lex team at the Financial Times. It introduced the Scepter bid thus:
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Cook flagged a US dollar offer equivalent to $5.30 a share for Santos. Supplied
"Plan A: reduce the world economic system to chaos! Mwa Ha Ha Ha. Plan B: buy an Australian natural gas producer for a reasonable sum and make a solid profit if energy prices recover. The merchant bank Scepter – which may or may not be a front for Spectre – put in a cash bid for the Australian producer Santos on Wednesday." Last contact
Coates' final contact with Scepter arrived by proxy and on home territory.
On an August morning last year, a team from Harbour Energy took the lift 18 floors up from their office in Sydney in the Gateway building. Coates was waiting for them in the Santos office on the 38th floor. He was delivered with one of the classic non-binding, highly conditional and uncertain approaches that are easy to reject until they become public. Harbour indicated it was prepared to pay $11 billion for control of Santos.
Cook flagged a US dollar offer equivalent to $5.30 a share for Santos. The foreshadowed price represented a 21 per cent premium to the then price and an 85 per cent hike on a 12-month low. And Coates was told that the biggest contributor to the funding of the bid would be his new friends at Scepter.
Coates resisted because the indicative price was nowhere near enough to open the doors to the due diligence private equity demands. Effectively then, the pitch was stillborn. And, at least he way the Harbour team tells it, Coates and his advisers recommended that if Harbour was contemplating a return then it might do better to come back without Scepter.
Others close to the construction of the deal say that Scepter did not have to be encouraged to leave the tent after the August rejection. Their alternative view is that Scepter left Harbour to its own devices in the firm belief that the price Coates was looking for was just too high.
The delay forced by Scepter's ultimately sensible decision not to endure rejection for the third time proved terminal to Harbour's hopes of success. Cook had hoped to get a new offer to Santos by Christmas. Instead she had to go back and collect new and deeper pools of equity and debt. And by the time Harbour returned to the fray, it was chasing rising oil markets rather than cannily anticipating recovery. Through August oil prices ranged around the $US55 a barrel. By the time Harbour returned to the fray on April 3 armed with a $6.50 a share offer, oil had cracked $US70 a barrel and the market was seeing only upside.
But the changed environment wasn't limited to markets.
In the interregnum between first approach and landing a bid big enough to earn due diligence, the hard-headed Coates had been replaced in the chair by former Woodside executive Spence.
Spence shared a professional pedigree with the man Coates had hired to replace Knox as CEO, Gallagher. Spence was Gallagher's chairman when he was CEO at Clough and they were once senior management colleagues at Woodside.
Spence proved to be very much his own man. Indeed, in retrospect, he offered the first public indication that Harbour was playing a losing hand. In hosting his first Santos annual general meeting on May 2, Spence observed that the advance of the oil price since discussions began in April might need to be translated into a higher bid price.
Needless to say, the commentary came as a surprise to Harbour. Soundings were taken. Assurances were offered and accepted and false hopes were embedded.
It is said that on the morning of her ultimate rejection Cook awoke to a text message from one of her Santos go-betweens. It promised she would be advised when it was time to crack open the champagne. That text never came.
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