Top broker delivers verdict on Santos (ASX:STO) merger with Oil Search (ASX:OSH)

The merger of Santos and Oil Search will create the biggest oil & gas company on the ASX, but is bigger really better?

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The Oil Search Ltd (ASX: OSH) share price continues to rocket following Santos Ltd (ASX: STO) merger bid.

The Oil Search share price jumped 4.6% to $4.08 in after lunch trade. This makes it the second best performer on the S&P/ASX 200 Index (Index:^AXJO) after the Pilbara Minerals Ltd (ASX: PLS) share price.

In contrast, the ASX 200 added 1.1% and the Santos share price gained 2.5% $6.65.

Oil Search share price further out of reach

The outperformance of the Oil Search share price is making it harder for Santos to win over its target with its all-scrip deal. The Santos share price has dipped 2.6% since it confirmed it had submitted a non-binding offer to Oil Search.

On the other hand, the Oil Search share price has surged nearly 11%. The market is betting that Santos will have to up the ante if it’s serious about consummating the merger.

Santos is offering to swap 0.589 of its shares for each Oil Search share. Based on the current Santos share price, the offer works out to $3.92 for the Oil Search share price.

Most experts believe the merger between the two that will create the biggest oil and gas company on the ASX makes sense. This includes UBS.

“We are supportive of the strategic rationale to merge and believe the proposed merger would be both value and FCF accretive,” said the broker.

“However, to reach a mutually agreeable all-scrip deal, STO’s share price would need to lift from the 20 July close ($6.49/sh) and/or STO may need to offer a higher scrip ratio, in our view.

“We estimate that STO could increase the scrip ratio up to 0.60 beyond which the merger economics would become value dilutive to STO shareholders.”

Santos under pressure to up its offer

Morgan Stanley also feels that Santos looks like a bit of a scrooge. The broker noted that the offer price is good for Santos but not for Oil Search, reported the Australian Financial Review.

“On our valuation, the indicative ratio should be closer to 60% Santos and 40% Oil Search shareholders,” said Morgan Stanley.

Better than even chance of Santos-Oil Search merger

While Oil Search is discouraging shareholders from taking the bid seriously, it recognises the strategic logic of merging the two ASX shares.

It’s more the price that Oil Search is scoffing at as the offer only offers around a 6.8% premium to its shareholders.

That’s not much of a takeover premium, although Oil Search missteps has given its suitor a stronger hand.

Oil Search just lost its chief executive under controversial circumstances and its chairman has been criticised for his handling of the M&A disclosure.

Given that Oil Search is looking like a wounded duck, the odds are in favour that a merger will proceed assuming regulatory clearances are not an issue.

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Motley Fool contributor Brendon Lau owns shares of Santos Limited. Connect with me on Twitter @brenlau.

The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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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