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Why Woodside Petroleum Limited was right to reject Oil Search Limited

Woodside Petroleum Limited’s (ASX: WPL) proposal to merge with Oil Search Limited (ASX: OSH) was announced nearly three months ago with 0.25 Woodside shares offered for every Oil Search share.

Earlier this week, Woodside informed the ASX that is has withdrawn its proposal to merge the businesses. This is a win for Woodside shareholders even though some might not know it.

Growth

If you follow the financial news, you’ll find articles saying Woodside “remains under pressure from shareholders to utilise its relatively robust financial position to maintain growth” and headlines mentioning: “Woodside’s growth dilemma”.

It is unlikely that these “huge issues” are being announced by smaller shareholders, but likely by bigger institutions focused on Woodside growing production levels at all costs with less regard to its return on assets.

The shareholders pressuring Woodside to make acquisitions and expand into a declining commodity market should look at the recent history of major acquisitions made by Rio Tinto Limited  (ASX: RIO) in the resources sector and BHP Billiton Limited  (ASX: BHP) in the energy sector. Major acquisitions have a nasty habit of providing poor returns to shareholders, and not just in the resources industries.

High-quality assets don’t come with a cheap price tag, especially when the target company has a healthy financial situation and no need to sell, such as Oil Search. If the Oil Search acquisition was approved and gas prices continue to slide, it is likely that Woodside would have struggled to make a decent return on the acquired assets.

Quality business

Woodside has low levels of debt and several high-quality production assets in Australia and various exploration assets across Asia, Africa, North America and South America that can provide growth in the future.

By walking away from the Oil Search offer, it maintains its strong financial position. As oil and gas prices continue to slide, energy companies around the world are watching their profits dwindle and some will be forced to sell assets to manage debt – Woodside will be waiting.

In the meantime, the business will continue to do what it has always done – explore, find and produce gas.

Growth at all costs will usually do exactly that; cost shareholders. Woodside has shown restraint by not increasing its bid for Oil Search and in doing so has saved shareholders from a potentially poor-returning asset.

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Motley Fool contributor Mitch Sonogan 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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