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Oil Search/Santos announcements highlight the dangers for boards considering proposals

By Michele Muscillo / 20 July 2021
9 min.
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Worthwhile read for: Investors, Shareholders, Company directors, Board members

It is the start to another ordinary day. You sit at your desk and fire up the laptop scanning the overnight news when you hear the unmistakable “ping” that heralds a new email arriving.  

But it is no ordinary email. In bold letters in the subject line is written “non-binding indicative offer”.

You almost spill your coffee as you scramble to double click the attachment to read what is in store.

Your day is ordinary no longer.

What is received is a confidential indicative offer from another ASX listed company to seek to acquire your ASX listed company by way of a “friendly” merger. You take a moment to consider the irony of the inclusion of the word “friendly” as you read on to discover that the acquirer requires a response within 48 hours of the receipt of the email and that time is now ticking.

What to do.

You form a mental checklist of the things that need to be done in short order to ensure a response:

  1. Panic – you seem to be well on top of this one.
  2. Call the Chair so the board can be advised, they will need to be on standby for the next 48 hours.
  3. Legal advisors – what are our obligations?  Disclosable? How to respond? There are probably a hundred questions that you haven’t even thought of at this stage, but it is fair to say you will need a mergers and acquisitions expert moving straight away to properly advise the board of their fiduciary duties.
  4. Defense advisor – do we have one? Are they mandated? All that wincing that you and your board did at the time of looking at the percentage fee that would ultimately be payable on a successful (or unsuccessful) defense seems insignificant right now.  You need them in your corner and up to speed straight away – like five minutes ago – to help you work out whether the offer is something that is credible, something that could be accepted and tactically what you should do in response.  
  5. Cancel the rest of your day.

Once all the pieces are in motion and all the relevant parties are briefed it is time for a seminal meeting; a meeting of the board to consider the non-binding indicative proposal and to approve some form of response to the acquirer having taken advice from the relevant advisors.  

Of course, what gets said at this meeting depends upon the relative merits of the proposal and the likelihood of a better proposal being solicited from the proposed acquirer or a third party. However, any board doing a fair job will consider at this meeting the merits of rejecting the offer outright.  

At this meeting the legal advisors provide a written and oral synopsis of the law around takeovers and a summary of the directors’ duties applicable in the event of a receipt of a non-binding and indicative offer.  They advise that in this circumstance given the nature of the approach, no disclosure to ASX would be required. The financial advisors provide a detailed valuation presentation which compares the offer to a number of valuation scenarios for your own company. 

At least on some of the metrics the offer looks cheap. The board is heartened. You start to hear words being thrown around the boardroom table such as “too cheap”, “opportunistic” and “we can do better”.  Discussion then turns to the draft rejection letter and whether the word “reject” should be bolded and underlined or simply left in bold.

It has been a stressful 48 hours.  A significant amount of work has been undertaken by management and ultimately, despite the chaos, the board has reached a reasoned decision.  

What if…

The above represents an entirely fictitious but not so altogether atypical set of circumstances that could arise in the event of an unsolicited offer from a third party. The first 48 – 72 hours are truly chaotic (generally devised to be so by the acquirer).

But somewhere in that process a moment of pause is needed. Someone in the room needs to consider a few what ifs:

  • What if despite the valuations received (with all their assumptions and qualifications), the price would be seen as a fair price for the company?
  • What if the company’s shareholders want to sell? 
  • What if, even if the offer price doesn’t seem quite right, the old adage of “1 plus 1 equals 3” applies?
  • What if we reject and the acquirer goes hostile – are we in a position to be able to fight them and continue to run our business?  Do we have the funding?

And perhaps most critically, this one:

  • What if we reject and continue independently, and the market subsequently finds out that we confidentially rejected an offer?

Santos Proposal for Oil Search

Enter the “in real-life” scenario now confronting the board of ASX listed Oil Search Limited as announced to the ASX on 20 July 2021.

The emerging factual scenario makes for some interesting reading.  

  • On 25 June 2021, ASX listed Santos Limited submitted a confidential, non-binding indicative all scrip merger proposal to Oil Search. Delivery of that merger proposal followed some months of discussions between Oil Search and Santos Limited.
  • On 9 July 2021 (no doubt following numerous discussions, board meetings and advices) Oil Search provided a letter to Santos which rejected the merger proposal. Given that (one can assume) the original merger proposal of 25 June as well as the subsequent rejection were all considered confidential and subject to ASX carve-outs, no ASX announcement was made by either party at the time regarding the discussions.
  • However, on 19 July 2021 in response to questions raised in an investor briefing (no doubt made innocently), Oil Search stated that there had been no change of control proposals made to the Oil Search board.
  • Whether Santos or its advisors objected to that answer or, as indicated in the Oil Search announcement of 20 July 2021, the market needed to be better informed, Oil Search then released the following statement: OSH has recently received a confidential and non-binding and indicative change of control proposal.  That proposal has been carefully assessed by OSH’s board and senior management… and our advisors…following that assessment, that proposal was rejected as it was determined not to be in OSH shareholders’ best interest on the terms and value proposed.
  • On the same day, 20 July 2021, the cat being now well and truly out of the bag, Santos released its own summary of the discussions with Oil Search and, helpfully, a copy of its original proposal of 25 June 2021.

Time will tell what the market and, importantly, Oil Search shareholders make of the situation, however a few points are relevant to note here:

  • The closing price of Oil Search shares prior to the 25 June 2021 proposal ($3.78) remained very close to yesterday’s close (prior to the market becoming informed) of $3.67.  
  • Santos appears, as per their announcement of 20 July 2021, to still be interested in pursuing a transaction – they state, “Santos continues to believe that the Merger Proposal represents an extremely attractive opportunity to deliver compelling value accretion to both Santos and Oil Search shareholders”.

It could be that, now that the market and Oil Search shareholders, are informed both companies will be forced back to the table. Given that the relative prices have remained static (Santos is also trading within 5 cents of where it was on 24 June 2021), it may be a case of “no harm, no foul” if the merger is to proceed.

But what if Santos had moved on?

What if Santos released an announcement which said something along the lines of “we made an offer in June which was rejected, and we have moved onto other endeavors”.

No doubt there would be some Oil Search shareholders who would consider the board was justified in their view, but hypothetically speaking for our what if scenario, it is possible that some, many, or most shareholders of a company in such a circumstance would consider otherwise.  And whilst it should go without saying, the interests of the party not in the negotiation room but arguably the most important – the shareholders – need to be kept front of mind. Boards also need to consider that, there is a chance in such high stakes transactions that a “confidential” approach and rejection may not stay confidential forever.  

So, what lessons can we learn from the Oil Search/Santos scenario and our hypothetical example above.

First, the critical nature of getting sound legal and strategic advice as to the board’s options. An unsolicited bid can be a very stressful time where competing interests dominate discussions.

Understanding the critical considerations and filtering out the noise can be the difference between making a sound decision and one which could have repercussions for a board.

Secondly, it is important to document that advice, the valuation, the strategy, and recommendations so that the board’s thinking can be easily ascertained should a regulator (or someone else) wish to examine the decision in the future.  

Thirdly, it’s a tough job.

I often suggest that it is in takeovers where directors (including non-executive directors) “earn their pay” given the difficult decisions often faced by them.

What the above scenarios teach us is that directors (including non-executive directors) need to ask the what if question before forming a decision on the desired strategy. They also need to be prepared for the possible fall out of their decisions if the worst case scenario comes to pass, and the decision is measured in the court of public opinion.
 

Authors
Michele Muscillo
Partner
Michele is a Partner in our Corporate practice and he has practised exclusively in corporate law for the duration of his legal career.

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