Santos: more gas, bigger tank The energy giant's interim results were overshadowed by a big new acquisition and it's a good one. by Gaurav Sodhi 28 Aug 2018 5 min 0 A transformational, debt funded acquisition from a recently struggling commodity businesses isn’t exactly our idea of investing nirvana. Yet Santos’s acquisition of Quadrant Energy is a genuinely good deal. Before we get into the meat of the acquisition lets briefly review the company’s interim results. They were fine. Higher oil prices and better operating performance have brought profits back to acceptable levels and Santos is using cash to repay debt. Key Points Fine results Excellent new acquisition New Santos is better quality All that, however, was secondary to the big acquisition. The deal does a lot to address our criticisms of Santos, at once solving several problems. The most important is an improvement in its asset base. From fair to great We’ve argued that Santos’s assets are, at best, fair. The Cooper Basin has been extensively milked and is now a capital-intensive business; GLNG generates poor returns on capital and, in the absence of high oil prices, always will; the Asian business isn’t great either. The Western Australian gas business is steady and generates strong cash flow, while PNG LNG is a genuine jewel. To this we now add the substantial asset base of Quadrant, which brings three major domestic gas hubs into Santos’s control as well as a large inventory of gas that can be used as backfill to extend the lives of those assets. Santos interim result 2018 2018 2017 +/(– (%) Revenue (US$m) 1,680 1,449 16 EBITDAX (US$m) 883 718 23 U'lying profit (US$m) 217 109 99 NPAT (US$m) 104 (506) n/a Net debt (US$m) 2,437 2,928 (17) The numbers tell the story. Quadrant’s steady, high-margin business will lower costs by at least 10%, increase reserves by a quarter and output by a third and will also generate more free cash flow. All of Quadrant's sales are on long-term, inflation-linked contracts and it generates a 75% operating margin compared to the 50% margin of the Santos only business. Yes, this is a great deal.
The only negative for Santos is that it must re-gear a balance sheet that has been stretched for years and it must forgo some of the upside of a large recent oil discovery offshore WA. That shouldn't matter too much as Quadrant's revenue can support higher debt and Santos will still be the major beneficiary of the Dorado discovery. Makes cents Santos will pay US$2.15bn for Quadrant and will take another US$1.2bn to fund the deal, taking net debt back to US$3.6bn. Not only does the deal make eminent strategic sense, it also appears rather cheap. All told, Santos is paying less than $10 a barrel for reserves and, in terms of profits, the deal was done on a pre-depreciation multiple of four times. This is dearer than asset sales made by Santos but these assets are a lot better than average. Quadrant operates the Devils Creek, Varanus Island and Macedon gas hubs which process gas. These are really more manufacturing facilities rather than traditional commodity assets. Linked together with Santos’s gas assets, they should mean greater margin and cash flow for the combined business. As a minority owner of some of these hubs, Santos knows these assets well. Redemption We’ve been scathing of Santos in the recent past, especially for not shrinking when threatened by debt and not selling when good offers were on the table. This deal dramatically improves the asset quality and goes some way towards redeeming management. Higher oil prices have also helped to bring the company back from a precarious position. We'll take a closer look at the combined entity in due course but, for now, we're moving our price guide sharply higher, with our Buy price moving from $3 to $5 and our Sell price rising from $5 to $8. Our risk ratings also fall from Very High to High and our recommended maximum portfolio weighting rises from 3% to 4%. HOLD.
(%) Revenue (US$m) 1,680 1,449 16 EBITDAX (US$m) 883 718 23 U'lying profit (US$m) 217 109 99 NPAT (US$m) 104 (506) n/a Net debt (US$m) 2,437 2,928 (17) The numbers tell the story. Quadrant’s steady, high-margin business will lower costs by at least 10%, increase reserves by a quarter and output by a third and will also generate more free cash flow. All of Quadrant's sales are on long-term, inflation-linked contracts and it generates a 75% operating margin compared to the 50% margin of the Santos only business. Yes, this is a great deal.
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