It’s been a roller coaster of a ride for Oil Search (OSH)
It has been a wild ride for OSH shareholders over the past year. In September 2015, OSH received an indicative proposal from Woodside Petroleum (WPL) to acquire all shares in OSH at the rate of one WPL share for every four OSH shares. The market reacted favourably to the news, as shown in the figure below, with the share price jumping to $8 soon after the announcement. In November 2015, the WPL proposal was cancelled, causing a large drop in OSH share price. More recently, OSH offered to buy all of the shares of InterOil, a Papua New Guinea (PNG) based natural gas company that owns the Elk-Antelope gas fields in PNG. The market reaction to this was muted, with the share price staying well within the range for the prior couple of months. The offer was progressing when, yesterday, OSH was informed that Exxon Mobil has submitted a competing bid that is significantly more attractive to InterOil shareholders, and therefore would likely be recommended in favour of the OSH bid. Interestingly, the OSH share price has so far rallied on this news, indicating that perhaps the Exxon offer would indirectly benefit OSH. Who is InterOil and why are both of these companies interested in acquiring it?
Figure 1: Oil Search share price
InterOil Corp. holds natural gas assets in PNG and is headquartered there but is listed on the NYSE. The InterOil natural gas assets are of particular interest to Exxon and OSH because these two companies jointly own the only LNG export plant in PNG. InterOil has expressed interest in developing a second export plant, however, clearly this plant would compete for customers with the Exxon-OSH plant. It therefore makes sense for both of these companies to want to acquire InterOil to ensure they maintain their monopoly on LNG export from PNG. Furthermore, from a general economic point of view, upgrading the existing LNG plant to cope with the natural gas coming from the InterOil assets is obviously a far more cost effective solution than building an entirely new plant.
Readers may be wondering what an LNG export plant is exactly. Natural gas, as the name suggests, naturally exists in gaseous form. In a gaseous state, it is quite inconvenient to transport because it occupies a very large volume for a given quantity. By cooling the natural gas, it can be forced into a liquid state, making it much more convenient to transport, although it must be kept at extremely low temperatures to remain in a liquid state. The LNG is then generally transported by specially designed ships for international export. While this cooling and compressing process sounds simple, it actually requires a lot of cooling power with expensive plant and equipment required for the process. This makes LNG export plants very expensive to build (~$19bn for the PNG LNG plant), meaning that the owners will work hard to protect their investment.
The current Exxon bid values InterOil at around $2.5bn, compared to the OSH bid of $2.2bn. Simultaneously with its bid, OSH reached an agreement with French company Total to sell, for cash, around 60% of certain InterOil assets, the cash presumably being used to help OSH fund the deal. Unfortunately for OSH, Exxon is a far bigger company and can afford to pay a higher price for InterOil without the need for any external help. For this reason, it is both unlikely, and perhaps unwise, for OSH to get into a bidding war with Exxon. The probable course of action for OSH, therefore, is to let the three day deadline to match the offer expire and allow InterOil to formally change its recommendation to endorse the Exxon offer. Losing out to Exxon may not be all bad news for OSH. Firstly, some analysts think that the merger between Exxon and InterOil will lead to Exxon upgrading the capacity of the existing LNG plant; a far more cost effective strategy than building a new plant. As a joint venture partner, OSH would benefit from this arrangement and would not have to worry about trying to compete with a second plant. The costs associated with the offer so far would be covered by a break fee of US$60m that OSH is entitled to receive (although 20% would go to Total) in the case that the arrangement is terminated by InterOil.
None of the stocks mentioned here are currently held in any Rivkin portfolios, however, takeover deals like this are the main focus of our event strategy. This particular event did not fit all of our criteria however new opportunities arise regularly and we are constantly checking whether anything arises that fits our selection criteria for inclusion in the Rivkin Event Strategy. Click here to read a blog post discussing the Event Strategy.