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Could Woodside Petroleum buy Oil Search?

Oil Search  (ASX: OSH) could be bought by Woodside Petroleum (ASX: WPL) for as much as US$13.1 billion according to analysts at company CIMB Securities. Oil Search is forecast to quadruple its energy production from 2015 as the PNG LNG project the company has a 29% stake in comes online. This production could fill a growth gap faced by Woodside in the medium-term brought about by delays to current projects Browse LNG and exploration in Israel.

Woodside is currently in a unique position. As one of Australia’s major oil and gas producers, along with the likes of BHP Billiton (ASX: BHP) and Santos (ASX: STO), Woodside has several significant growth projects under evaluation, but the long lead times before the company’s next set of projects come online means it faces a period of low capital expenditure and gushing cashflows from existing projects.

The strong cashflows are largely coming from the $14.9 billion Pluto LNG plant, which was successfully brought into production in April last year. With Pluto’s help, Woodside’s first quarter 2013 production increased by 55%, with sales up 50% and revenue up 21% to US$1.44 billion. With Pluto now completed, capital expenditure for the first quarter was down by 70%.

In response to the cash influx Woodside announced a special dividend of US$0.63 per share in April to distribute the earnings back to shareholders. But with the delays in upcoming projects Browse LNG and prospective exploration off the coast of Israel, an acquisition is seen by some analysts as a likely stop-gap measure to maintain growth.

According to a Bloomberg report, analysts at Commonwealth Bank (ASX: CBA) view Oil Search as being undervalued, stating that the current share price of $7.93 does not factor in the likely expansion opportunities of the PNG LNG project.

Oil Search had a market capitalization of $10.58 billion at the end of last week, so if an offer of US$13.1 billion (A$14.12 billion) was made it would represent a sizable premium to the current share price. But it could be a viable option given any new major projects for Woodside are at least five years away.

Foolish takeaway

Shares in Oil Search have increased 25% in the last 12 months, while shares in Woodside are up 10%. If Woodside elects not to look for acquisitions in the near term, shareholders will still be rewarded with strong dividends. The company is targeting a dividend payout ratio of 80% of underlying net profit after tax which is expected to be maintained for several years.

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Motley Fool contributor Regan Pearson does not own shares in any of the companies mentioned in this article. 

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