The Explanatory Memorandum and Independent Expert Report (IER) on the WPL merger with BHP Petroleum has revealed some noteworthy points along with some curiosities.
The timetable for the merger reaffirms the completion date of 1 June 2022. Under the share sale agreement, the merger took economic effect from 1 July 2021. The merger ratio was agreed at 52% for WPL and 48% for BHP and this will not change on completion date. But the two companies must square up for the period between the Implementation Date (1 July 2021) and the completion date (1 June 2022) for the cashflow from the BHP Petroleum assets and the dividends from WPL as offsetting elements.
On completion, WPL will pay BHP approximately US$830 million in relation to the dividends paid by WPL for that period. BHP will also receive approximately US$370 million in WPL shares from the dividend reinvestment program.
On the flip side, there is a ‘Locked Box’ payment which is effectively a payment from BHP to WPL for the cashflow generated by the BHP Petroleum assets across the same period, less any cash as at the Implementation Date. WPL is entitled to approximately US$1.6 billion of net cash flow less any cash remaining in BHP Petroleum at completion.
Buried in the documents as a script note was the revelation that BHP Petroleum intends to divest its Algerian assets and keep the proceeds.
Over the last five years, these assets have delivered average annual EBITDA to BHP of US$160 million, reported net assets of US$433 million in FY21 and 5-year capex total of just US$44 million. In FY21, Algeria produced 3mmbbls of oil for BHP Petroleum.
On the back of an envelope, the Algerian assets could be worth say US$500 million to BHP. Not all BHP shareholders are eligible to receive the in specie distribution of WPL shares. BHP estimates that approximately 47 million WPL shares are in this category. These shares represent about 4% of the WPL shares to be issued and will represent an overhang to the WPL share price post-merger. BHP investors who do not want to keep their WPL shares will be selling at that same time as these ineligible shares.
About 59% of the BHP Petroleum assets by value are located in the Gulf of Mexico (32% in Australia) as determined by the IER. In our view, the IER has overstated the GoM value by US$2-3 billion due to overly optimistic assumptions on capex and production.
The IER does reveal the expected D&R (decommissioning and removal) costs expected for Bass Strait through to 2039 as US$2,563 million. This number has been the subject of much speculation and may be one reason why both partners in the Bass Strait joint venture have struggled to sell the asset in recent years.
Investment view
The Explanatory Memorandum and Independent Expert report sought to answer the question: “Is the value of the merged group greater than the value of WPL on its own?” It did not attempt to conclude if the transaction was in BHP shareholders’ interests, so that remains subjective.
As with any detailed report of this nature, there are innumerable assumptions and sets of data to be considered. For example, over the expected 27 year project production at Scarborough from its startup in 2026, the IER tells us that the total life of project operating expenditure is US$17,575 million comprised mostly of fixed rate tariffs for processing gas along with a variable pass-through of opex incurred by Pluto Trains 1 and 2 in processing the gas. The detail of the applicable tariffs is omitted making any sensible analysis of the value calculated by the IER impossible and therefore the valuation of BHP’s Scarborough asset cannot be satisfactorily determined by the reader of the report.
Regardless, the IER gives plenty of insight into the existing assets of BHP Petroleum. In the future, it paints a picture of strong short term cashflow generation (WPL too) but lays out a production decline and capex requirement to ease the decline that the market continues to underestimate for both companies.
BHP obviously thinks the IER’s positive recommendation of the merger is the right decision, and it will leave BHP unhitched from the oil and gas industry as it intended.
The future for BHP is now firmly focused on ‘future facing’ materials including copper, nickel, iron ore and potash. We think the company will eventually exit its metallurgical coal business.
Risks to investment view
Demand and prices for commodities could decline, or operational costs could rise more than expected. There is transactional risk if the merger of BHP Petroleum and WPL does not proceed.
Recommendation
We have retained our Hold recommendation.
