Speculation BHP will takeover Woodside

Wednesday, April 06 2011

Speculation BHP will takeover Woodside

The financial press has been speculating that BHP will takeover Woodside Petroleum in a $40bn deal. There are a number of reasons that a BHP and Woodside deal would be a possibility:

  • BHP’s growth strategy is to “own long-life, low-cost, export-oriented, expandable assets”. They have stated they are interested in oil and gas. Woodside fits this criteria.
  • It is understood BHP was not happy that it wasn’t offered Shell’s 10% stake in Woodside when they sold last November.
  • Shell holds a remaining 24% stake in Woodside valued at $9bn. An unknown company last week exchanged EUR 9bn into Australian currency, prompting more speculation about BHP.
  • The press reports have been deal specific with advisors named for BHP and Woodside and details of a $58 offer price.
  • BHP ran into regulatory headwinds with its failed bid for Potash. A BHP/Woodside tie-up will unlikely face political backlash.

To be clear, Dalton Nicol Reid never invest on takeover speculation. Our purchase of Woodside was based on fundamental reasons. Woodside offers leverage to oil prices which we view favourably and is trading below our valuation of the company. Recent economic data from the US indicates a recovering US economy and this bodes well for oil prices given the US is the largest consumer of oil. The below chart shows the correlation between the oil price (red line RHS) and Woodside’s share price (blue line LHS). Woodside has been a reliable proxy for exposure to oil but the relationship has broken down in recent months. This makes little sense and we believe this disconnect is overdone and expect this gap to close over time.

Thesis

Oil price leverage. Woodside offers strong leverage to the oil price via their large oil and condensate volumes as well as oil linked contracts in their liquefied natural gas (LNG) projects.

  • Continued unrest in the Middle East will support oil prices.
  • The nuclear meltdown from the Japan earthquake will see a shift to alternative sources of energy. Woodside will benefit as LNG is the likely source to replace lost nuclear supply.
  • Recent economic data from the US indicates a recovering US economy and this bodes well for oil prices given the US is the largest consumer of oil.
  • Valuation. Trading at a discount to NAV. Woodside shares offer upside to their expanding LNG portfolio particularly driven by Pluto 1 start-up in August this year.
  • Recent concerns on coal seam methane projects could create buying interest in Woodside.  It certainly makes their projects look more economic. Origin announced a change in terms with ConocoPhilips which reflects a deterioration in the economics of those projects. Additionally, we are hearing Santos is already experiencing cost escalation.
  • We expect progress on further project development in the next six months, namely third party gas deals (we understand they are in advanced negotiations), Pluto 2, and possibly Browse.
  • The portfolio was underweight the energy sector and our thematic of higher oil prices due to an improving US economy, demand from the Japan earthquake and instability in the Middle East highlighted the opportunity to increase exposure in the energy sector.

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