Why did Santos just raise $1.5bn?
Santos caught investors off guard today when it announced a capital raising for $1.5bn. With a market capitalisation of $7.8bn this represents almost 20% of the market cap. STO has been suffering from low oil prices which have only this year started a gradual recovery from a plunge that began in 2014. In addition, STO has a relatively high debt load with approximately $5.2bn in long term debt (as at 30 June 2016) giving it a debt to equity ratio of over 80%. Despite this, investors were of the impression that current earnings and cash flows would be sufficient to internally shore up the balance sheet over the next couple of years without the need for further capital raisings. Part of this impression came from a strategy day, held by STO only a week ago, at which it outlined its goals going forward. The company highlighted its plan to reduce net debt by $1.5bn over the next three years by utilising its free cash flow and through sales of its non-core assets. At no point was any raising of equity either stated or implied. The update also highlighted that STO has reduced its operating costs by $8 per barrel and that 2016 sales volumes were expected to be at the top end of the previous guidance range. Furthermore, every $10 per barrel increase in the price of oil is expected to add US$300m to the operating cash flow of the company.
Investors got a shock, therefore, when STO announced that it has placed $1.04bn in new stock to institutional investors at a price of $4.06 and it intends to raise a further $500m through a share purchase plan. Given that the oil outlook has improved significantly in recent weeks and months, partly as a result of an agreed output cut by OPEC members, the reasons for the equity raise are somewhat unclear. Some analysts believe that it could be used to fund growth, for example, to invest in the PNG LNG project currently underway. The move is still a little disappointing for shareholders who have now been diluted and will theoretically reduce any possible upside in the valuation of the company.
At the very least, the capital raising will substantially shore up the balance sheet and protect the company from any possible future shocks to the business. Many would argue that the raising was opportunistic given the high oil price and reinvigorated optimism in the sector. STO would potentially fit in an investor's portfolio as a relatively risky, leveraged play on the price of oil. Having said this, STO isn't currently held in any Rivkin portfolios.
This article was written by William O'Loughlin – Local Investment Analyst, Rivkin Securities Pty Ltd. Enquiries can be made via firstname.lastname@example.org or by phoning +612 8302 3600.