Oil and gas play Santos Limited (ASX: STO) has finally admitted that it needs to shore up its balance sheet, announcing a $2.5 billion capital raising today.
The news comes after almost a year of speculation that the company needed to raise capital to reduce the amount of debt on its balance sheet, following the halving in oil prices. Santos has around $9 billion in debt on its books – most of that associated with the company's stakes in the Gladstone and PNG LNG processing plants.
The rights issue will be conducted at around a massive 35% discount to the last share price of $5.91, of $3.85. A year ago, the company's shares were changing hands at above $12. In March this year, investment bank Credit Suisse said 'the company simply must raise capital' in a note to clients. At the time, shares were trading around $7.00.
That is a massive erosion in shareholder's capital, and one has to question why management and the board didn't raise capital last year when oil prices first plunged. If the finance community could see why the company needed to raise capital, why couldn't management? In fact, if the CEO was worth his salt, why wasn't the company one step ahead of the game and raising capital before it became a major issue?
Instead, the board initiated a strategic review of all options and that the existing CEO would step down. That's a clear sign that the board were unhappy further action wasn't taken at an earlier stage.
The current situation is also a nice reminder to investors that too much debt on a company's books can be a capital and share price killer, even if the company can afford to pay the interest and make the debt repayments.
At the end of June 2015, Santos had $9 billion in debt, and $399 million in cash. Following the raising and some asset sales, Santos will cut its net debt back to $6.2 billion – but that's still an enormous amount of debt for a company that made just $37 million in profit for the six months to June 30.
The oil and gas producer has also been forced to amend its dividend policy to 40% of underlying net profit, slash its capital expenditure, as well as production, labour and supply chain costs.
Santos says that those measures, along with increased production should see the company generating positive free cash flow from 2016 – even if oil prices remain at US$50 per barrel. That's the good news for shareholders, even as they are forced to wear some of the pain of previous management's indecision.
Foolish takeaway
More than a fair share of resources and energy companies have lost their CEOs in the past few years for not taking action or adjusting their strategy fast enough, and destroying shareholder's capital in the process. Is that simply bad luck, a consequence of the tough industries they operate in or something else?
