Last month the board of gas producer Santos Ltd (ASX: STO) rejected a proposed takeover from Harbour Energy Ltd concluding that Harbour's offer undervalued the company.
Harbour was offering US$5.21, or A$6.86 per share, to acquire Santos. However the Santos share price today sits at $6.04, a 12% discount to the offer price. So are shares currently undervalued?
Perhaps; if you agree with the Santos board. One of the arguments the board cited when rejecting Harbour's 'best and final' offer was that the initial premium over the Santos share price had been eroded by a subsequent rise in oil prices and the offer thus undervalued the company.
There were also some important arguments about the deal being too complex and high risk for shareholders, but clearly the offered price was insufficient to compensate for those issues.
However to me the current discount of 12% suggests that shareholders are hesitant to assume the same value envisioned by the Santos board.
Arguments built on volatility
I think part of the hesitance could be around the board's assumption that company value should be determined by spot oil prices.
Oil prices are chronically volatile and although I'm sure the Santos board was acting in shareholders' best interests by insisting on a higher premium on the back of a short-term rise in oil prices, if I was valuing the company I would certainly use a longer-term forecast to set my expectations.
And, you know… if ever there was a company who should not gamble on oil price volatility it's Santos. After it boldly declared a move in 2013 towards oil-linked LNG pricing rather than set contracted pricing favoured by Woodside Petroleum Limited (ASX:WPL), the oil price promptly nosedived from US$100 per barrel to US$50 per barrel.
So how does the board expect to deliver its anticipated "superior shareholder value" going forward?
Santos reports that the current outlook for operating performance remains strong. Strong cashflows at the current oil price will help to increase the company's net debt position ahead of schedule (likely through an increased cash balance) as well as allow "restoration of fully-franked dividends in the near term".
Foolish takeaway
I take the view that the current discount to Santos' takeover offer shows investors are viewing Santos with a healthy does of scepticism after its recent history of disappointments.
If the company can deliver above these expectations for its coming half year results and full year guidance, there is a chance the company's share price will increase towards the board's view.
