Santos Ltd shares jumped on Friday on the prospect of a possible $52 billion merger with bigger Australian rival Woodside, but investors said valuation will be key, while domestic asset sales are likely to be needed to overcome competition concerns.
After market hours on Thursday, Woodside (WDS.AX) and Santos (STO.AX) confirmed speculation they were in preliminary talks to create a major oil and gas company, which together would have assets in Australia as well as Alaska, the Gulf of Mexico, Papua New Guinea, Senegal and Trinidad and Tobago.
The discussions are being driven by the need for the Australian companies to gain scale to fund the energy transition, analysts said.
The merged group would create a major global liquefied natural gas (LNG) producer that could attract more offshore investors as gas is seen as a key bridging fuel in the shift to cleaner energy.
Bigger global rivals Exxon Mobil (XOM.N) and Chevron (CVX.N) have also boosted their oil and gas reserves in multi-billion-dollar deals this year.
Santos shares jumped nearly 11% in early trade to hit their highest level in five weeks, but pared gains to settle up 6.2%. Woodside trimmed early losses and closed down 0.5%.
The merger discussions put Santos, the smaller of the two companies, firmly "in play", said Macquarie analyst Mark Wiseman.
"We expect this will trigger interest in STO (Santos) from other parties," he said in a note, adding that the company holds attractive assets at discounted values, such as PNG LNG.
Major European players with interests in the region could eye Santos, UBS analyst Tom Allen said. French giant TotalEnergies (TTEF.PA) co-owns LNG assets in Papua New Guinea and Australia with Santos.
Both Woodside and Santos have lagged the global energy equities boom amid struggles securing environmental approvals for major growth projects.
"It's a dramatic concentration of control," said Tim Buckley, a director at think tank Climate Energy Finance. "But I would emphasize it's coming from a point of weakness. It's coming from a point of ongoing massive underperformance."
UBS said a merger could unlock $200 million in cost savings.
A bid price with a sufficient premium to satisfy disappointed Santos shareholders is going to be the "biggest issue", said Matthew Haupt, a portfolio manager at long-time Santos shareholder Wilson Asset Management.
"I just don't know if Woodside are willing to pay up," he said.
UBS analysts modeled an implied bid price for Santos between A$8.20 and A$8.88, with the lower value reflecting a typical "control premium" of 20%. By comparison, Santos shares hit a high of A$7.58 on Friday.
Macquarie said its valuations suggest a Woodside-to-Santos scrip ratio of 0.31, a long way from Friday's close at 0.24.
The mooted deal would complete the consolidation of Australia's four biggest homegrown oil and gas companies. Woodside just last year combined with BHP Group's (BHP.AX) oil and gas business, while Santos acquired Oil Search in 2021.
COMPETITION CONCERNS
A merged entity would control about 26% of Australia's east coast gas market and 35% of the Western Australian domestic gas market, according to analysts, which could be a matter of concern for the country's competition regulator.
The Australian Competition and Consumer Commission (ACCC) said on Thursday it would consider if a public merger review into the impact on competition was required if the deal goes ahead.
However, a source with knowledge of the deal discussions said the companies could overcome any "significant concerns" from the ACCC by selling off some smaller domestic assets.
Jarden analyst Nik Burns said Santos' Varanus Island and Cooper Basin assets are likely candidates.
The issue will be getting agreement on price for mature assets in a market with only a handful of interested mid-sized players, for instance Beach Energy (BPT.AX), he said.
"What's the market appetite to take these assets? It's not like there is a large playing field of potential buyers," said Burns.
($1 = 1.5154 Australian dollars)
