On Tuesday, the Boards of two major companies rejected takeover proposals. Oil major Santos rejected a proposal from Harbour Energy and “terminated discussions”, while hospital operator Healthscope killed off two bids by deciding not to provide “due diligence access”.

Following closely on the heels of the AMP Board debacle, these actions represent further examples of Boards failing to understand what their real role is. The Board is there to govern on behalf of shareholders, not on behalf of the management team or themselves, and if this means working with a bidder to develop an appropriate offer, then that’s their job. It is then up to shareholders to decide whether to accept or reject the offer.

More so as both companies have been chronic underperformers. Not surprisingly, Santos shares fell by 8.4% yesterday to $5.90, while Healthscope retreated by a more modest 2.1% to $2.35.

Where does that leave shareholders in Santos and Healthscope? Let me answer this by looking at each bid and the reasons cited by the Board for the rejection of the offer.

Santos

Harbour Energy’s bid was to acquire 100% of Santos by way of a scheme of arrangement at a cash price of US$5.21 per share or approximately AU$6.86. They had also offered to increase this to US$5.25 per share ($AU$6.91) if Santos extended certain oil price hedging arrangements.

The Santos Board (the independent directors, including Chairman Keith Spence, and CEO Kevin Gallagher) resolved to reject the offer and terminate all discussions with Harbour Energy. It cited   three reasons:

  • Superior shareholder value could be realised by executing the existing strategy;
  • Offer price too low; control premium inadequate; and
  • Private equity transaction structure complex, high risk, uncertain and unequal treatment of shareholders.

The first two reasons are usually cited by companies under takeover offer and can be dismissed. It is not to say that they aren’t without merit, but the market (and shareholders) will ultimately form an opinion about these matters. Judging by the market’s reaction yesterday with the share price some 14.6% below the offer price, it is not rushing to back the Board’s view.

The third reason is more interesting in that the Board decided that the transaction had a high degree of uncertainty and therefore risk. Firstly, a protracted execution timetable due to the need to secure approvals from the Foreign Investment Review Board and the SA Government, and secondly, the offer was being made by a debt funded, private equity bidder with no Australian presence or synergies. In regard to the debt funding, this required support from Santos to facilitate, including significant oil price hedging. There was also an issue about “unequal” treatment of shareholders, with Harbour Energy having joined forces with major shareholders ENN and Hony who would be offered shares in the new vehicle.

ENN and Hony collectively own 15.11% of Santos and had agreed to work with Harbour on the proposal. Now that it has been rejected and the door shut, it is not clear what they will do with their holdings.

Harbour Energy had previously made three unsolicited bids to buy Santos prior to this offer (the first going back to 14 August 2017), and must be feeling quite miffed that shareholders haven’t been given the chance to decide. Will they back up their kitbag and go home? Only time will tell, but according to UBS, Harbour cannot make another bid for at least six months.

This means that Santos shares are likely to settle lower and trade according to movements in the oil price and Management’s success or otherwise in executing the strategic plan. Broker sentiment is marginally negative, with Citi downgrading to ‘sell’ from ‘neutral’. Of the major brokers, FN Arena says that there is 1 ‘buy’ recommendation, 2 ‘neutral’ recommendations and 2 ‘sell’ recommendations (also 2 ‘no ratings’). The consensus target price is now $5.78.

Healthscope

Healthscope Chairman Paula Dwyer led with her chin when announcing that the company would not be granting due diligence access to the two bidders on the same day as CEO Gordon Ballantyne detailed another profit downgrade. He warned that FY18 EBITDA would be in the range of $340m to $345m, down from last year’s $359.4m due to “softer than planned market conditions” and site specific issues with three Victorian hospitals.

The Healthscope Board had been considering a cash bid from a consortium involving BGH Capital and Australian Super at $2.36 per share, and a subsequent bid at $2.50 per share from global alternative asset manager Brookfield Asset Management Inc. Both bids were indicative, non-binding, and subject to a number of conditions including due diligence and arranging debt financing.

Dwyer read from the standard textbook when dismissing the bids:

“The Directors have carefully considered each proposal and concluded that neither proposal adequately reflects the long term value of Healthscope, nor its underlying assets nor future potential”.

To be fair to Dwyer and her Board, there were some issues in regard to the due diligence access sought by the bidders, with both parties trying to lock out the other party. This is complicated by Australian Super, Healthscope’s largest shareholder with about 14.0% of the shares, which has joined forces with BGH Capital and won’t support the bid by Brookfield.

But surely there is a way to allow due diligence to proceed on some form of amended terms, and if a binding bid emerges, that to be put to shareholders? We don’t need Boards acting as the arbiters of “value”.

Neither of the bidding parties looks ready to back-off and shareholder pressure will inevitably force the Healthscope Board to work with one or more of the bidders to extract an offer for shareholders. That’s why the share price only retreated marginally yesterday to close at $2.35.

As for the major brokers, they are mostly neutral on the stock with 1 buy recommendation, 6 neutral recommendations, 0 sell recommendations and 1 ‘no rating’. The consensus target price is $2.33.

The takeover battle for Healthscope is not over yet. When the next offer emerges, let the shareholders decide.