Hot on the heels of Origin Energy Ltd's (ASX: ORG) $2.5 billion rights issue, Santos Ltd (ASX: STO) announced a similar $2.5 billion pro-rata renounceable entitlement offer in November. The capital raising comes amidst the sale of Santos' 35% interest in Victoria's Kipper gas field and a $500 million placement to private equity firm Hony Capital.
Santos plans to use the proceeds to cut debt by $3.5 billion to withstand the downturn in oil prices. With the offer closing at 5PM (AEST) on Monday 30 November 2015 eligible shareholders must shortly decide if they wish to participate in the offer.
The offer
Santos is offering eligible shareholders the right to purchase new Santos shares on a 1 for 1.7 basis, at $3.85 each. An eligible shareholder is someone who held shares on the entitlement record date of 12 November 2015. The offer is renounceable, meaning rights could have been sold on-market (trading under ASX ticker STOR) until 23 November 2015.
As the offer is fully underwritten, if a shareholder does not exercise the right, Santos will sell the underlying shares at the market price and remit the difference between the sale price and $3.85 to that shareholder.
The offer closes on Monday 30 November 2015, with all valid acceptance forms needing to be received by 5PM Sydney time. Accordingly, eligible investors must decide if they will participate in the offer by Friday, in order to ensure enough time for clearance of funds.
The decision
Buying new shares under the entitlement offer is akin to doubling-down on your current Santos holdings. With entitlements being offered at the ratio of 1 for 1.7 existing shares (which is similar to Origin's 4 for 7 basis), investors looking to participate in the offer are effectively increasing their current holdings by almost 60%.
This ratio makes the offer highly dilutive, meaning investors that don't take up the entitlements are likely to be disadvantaged on an earnings per share basis.
However, as Warren Buffett has famously said, the number one rule to investing is: "don't lose money". Therefore, before jumping into the entitlement offer, investors must consider whether Santos remains a sound investment proposition.
The company
With net debt sitting at $8.8 billion before these capital management initiatives, Santos' fate is highly leveraged to future oil prices. Concerns around the strength of its balance sheet emerged as the price of crude oil tumbled almost 60% in 2014 and remains at historically low levels today. Resultantly, Santos' $2 billion capital expenditure burden (as at July 2015) associated with its two mega-LNG projects — PNG LNG and GLNG — appears to be the cause for the capital raising (given the strain on free cash flows at current crude oil prices).
Accordingly, investors deciding whether to participate in the entitlement offer must consider the impact this capital raising will have on the company's outlook.
The future
I, for one, believe Santos' future will be bright following the capital raising, which is why I'll be participating in it.
By reducing debt to a manageable level, without having to sell its best assets, Santos should weather the current downturn in commodity prices and come out stronger when demand for oil recovers.
Foolish takeaway
Although the entitlement offer is highly dilutive for existing shareholders, Santos' current share price is nearly 10% higher than the offer price. This should provide eligible investors with sufficient incentive to participate in the offer (for those that wish to make a quick profit).
In my view, however, investors should participate in the entitlement offer with a long-term outlook. With Santos retaining its crown jewel — its 13.5% stake in PNG LNG — and cutting debt, the capital raising allows Santos to prepare itself for a strong and sustainable future.
