4 reasons why Santos Ltd is no takeover target 

Investors shouldn't get caught up in the takeover talk surrounding Santos Ltd (ASX:STO). 

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With energy giant Woodside Petroleum Limited (ASX: WPL) making an audacious $12 billion takeover bid for Oil Search Limited (ASX: OSH) earlier this week, there has been renewed speculation of Santos Ltd (ASX: STO) becoming a takeover target. With investors considering the merits of Santos as a takeover play, here are four good reasons why it is hard to justify.

Balance sheet

Santos' balance sheet is in a poor state. Its FY2015 half-year presentation delivered last month showed its net debt as at 30 June was $8.8 billion. The majority of this debt is denominated in USD, meaning it is impacted by the AUD/USD exchange rate. Since June, the AUD/USD exchange rate has depreciated a further 7 cents. By Santos' own calculations, this increases its net debt by approximately $700 million, which puts the current net debt figure closer to $9.5 billion. With a market capitalisation hovering around the $4.5 billion mark, and even accounting for proposed asset sales, it will be hard to avoid a capital raising.

Commodity prices

Santos is operationally leveraged to the oil and gas price. To combat the 47% reduction over the past 12 months in the average realised oil price, it has reduced capital expenditure by more than 50%, and unit production costs by 11%. But it hasn't been enough. To remain free cash flow positive, it needs to sell oil at US$45 to US$50 per barrel at an AUD/USD exchange rate of between 70 cents and 75 cents. At present, neither metric is in its favour.

Australian dollar vs U.S. dollar

Which brings us to the AUD/USD dilemma. Within the next 6 to 12 months, many financial commentators are predicting the Aussie dollar will drop to the mid-to-low $0.60s. At 65 cents, net debt would reach a staggering $10 billion. An upshot would be an increase in the value of its U.S. assets, as well as operating cash flow, but that is little compensation against such a large debt.

Share price

Santos is down 45% year to date, and almost 70% in 12 months. But this doesn't mean the company is "a bargain". A takeover target needs to be attractive in more areas than just price. The fundamentals in Santos don't stack up at present, and it is difficult to pinpoint a company that could make a deal work.

Foolish takeaway

Santos is facing strong head winds with high debt levels, low oil and gas prices and a depreciating Australian dollar. Investors would be foolish to ignore the high risks of investing in Santos in the vain hope of a takeover offer emerging.

Motley Fool contributor Brett Bearham has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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