AUSTRALIA Santos STO AU Outperform Value on offer Price (at 05:44, 22 Oct 2015 GMT) A$6.32 Event Valuation A$ 11.96 - DCF (WACC 9.0%, beta 1.3, ERP 5.0%, RFR 3.8%) . STO advised that it has rejected an indicative, highly conditional and non- 12-month target A$ 7.50 binding proposal from Scepter Partners to acquire the company for a cash 12-month TSR % +23.6 consideration of A$6.88/sh (representing a 26% premium to last close and a Volatility Index High more material 29% premium to 1 month VWAP). GICS sector Energy Market cap A$m 6,560 Impact 30-day avg turnover A$m 54.1 . A fairly opportunistic offer: At A$6.88/sh, we estimate this implies an oil Number shares on issue m 1,038 price discounted by core and risked NAV of ~U$59/bbl and U$54/bbl, which

compares to longer-term futures curve at U$64/bbl and our LT normalised Investment fundamentals Year end 31 Dec 2014A 2015E 2016E 2017E assumption of U$80/bbl. Indeed STO also suggested that it did not reflect the Revenue m 4,037.0 3,314.5 4,245.3 4,904.0 "fair value of the asset base", let alone a premium for control. While offers for EBIT m 845.0 537.0 1,216.5 1,694.8 OSH would likely attract a premium vs. STO (given the differing quality of Reported profit m -935.0 127.0 485.9 883.8 Adjusted profit m 533.0 122.0 485.9 883.8 assets, growth prospects, balance sheet position, etc), a comparison of Gross cashflow m 1,777.0 1,429.2 1,846.5 2,344.3 Scepter’s offer vs. WPL initial offer for OSH perhaps highlights the CFPS ¢ 182.3 143.8 174.9 207.8 CFPS growth % 11.9 -21.1 21.6 18.8 opportunistic nature of the Scepter proposal. Indeed we estimate that the PGCFPS x 3.5 4.4 3.6 3.0 pricing terms imply a 15-50% discount to WPL’s offer for OSH (based on 1 PGCFPS rel x 0.42 0.49 0.42 0.39 EPS adj ¢ 54.7 12.2 45.8 78.3 month VWAP prior to the disturbed price) based on various valuation metrics. EPS adj growth % 5.4 -77.6 275.0 70.8 . Conditions could have also proved challenging: Despite the Board’s PER adj x 11.6 51.7 13.8 8.1 PER rel x 0.78 3.32 0.92 0.60 quick decision to reject the offer, we believe that this decision would have Total DPS ¢ 35.0 30.0 31.5 34.7 been better communicated if the formal conditions were also released (as was Total div yield % 5.5 4.7 5.0 5.5 Franking % 100 100 100 100 the case with WPL’s offer for OSH). Nonetheless, it would be fair to assume ROA % 3.9 2.3 5.1 7.2 that the conditions included the typical “no shop, no talk”, exclusivity, subject ROE % 5.4 1.4 5.6 9.2 EV/EBITDA x 7.1 8.2 6.1 5.0 to financing and due diligence provisions. While the bidder appears well Net debt/equity % 79.4 123.8 112.8 70.2 funded, any clauses surrounding exclusivity could hamper ongoing asset P/BV x 0.7 0.8 0.8 0.7 sales over an extended due diligence process. With no guarantees STO AU vs ASX 100, & rec history surrounding a potential transaction post due diligence, agreeing to the offer would significantly narrow STO’s options and leave the company exposed. . Asset sales appear the preferred option: With indicative offers for asset- levels also likely received (with the press reporting that initial offers could be announced in early November), we believe that the Board’s decision reflects the level of interest that has been received regarding specific assets. In our recent note, STO - No assets are sacred, we highlighted those potential asset scenarios and how the residual business could look. With the industry willing to buy assets at the forward curve and with STO reportedly receiving plenty of Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. interest in asset sales, we continue to see this as the more favourable option Source: FactSet, Macquarie Research, October 2015 to expose the value of STO’s asset base. That said, if Scepter were to (all figures in AUD unless noted) increase their offer by a mere 10% to ~A$7.58/sh, we believe such an offer

could not as easily be dismissed as opportunistic by the STO Board (particularly if concessions were made surrounding specific conditions). Earnings and target price revision . No change Price catalyst . 12-month price target: A$7.50 based on a DCF methodology. Analyst(s) . Catalyst: STO reports 3Q15 operating results on 23 October and we expect Kirit Hira +61 2 8232 9692 [email protected] will announce initial asset sales in early-to-mid November.

Action and recommendation 23 October 2015 Macquarie Securities (Australia) Limited . Maintain an Outperform rating and a A$7.50/sh target.

Please refer to page 9 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures.

Macquarie Research Santos

Value on offer . STO advised that it has rejected an indicative, highly conditional and non-binding proposal from Scepter Partners to acquire the company for a cash consideration of A$6.88/sh, representing a 26% premium to last close and a more material 39% premium to 1 month VWAP (which compares to WPL’s offer for OSH at a ~26% premium on a similar basis).

Fig 1 The offer price represents a 26% premium to the Fig 2 We continue to believe asset sales remain a last close, but a more material 39% premium to the one better alternative for STO than the current Scepter offer month VWAP (significant higher than WPL’s 26% (with both involving leakage of value to an external premium offered for OSH). party).

Premium to VWAP 9.0 STO NAV @ forward curve 45% STO/Scepter offer OSH/WPL offer post balance sheet repair (A$ps) 8.39 39.3% 8.5 40% 8.0 35% 7.5 30% 27.7% 28% 26.5% 7.0 6.88 26% 6.58 23% 25% 6.5

20% 6.0

15% 5.5 5.0 10% 4.5 5% 4.0 0% Equity Raising to return Sceptor's initial offer Asset sales and last close (undisturbed) 1 week 1 month 2017 FFO/ND to 30% residual equity raising

Source: Macquarie Research, October 2015 Source: Macquarie Research, October 2015

 Surprisingly STO did not disclose the conditions surrounding the offer. While the Board was quick to reject the offer as opportunistic in nature, we believe that this decision would have been better communicated if the formal conditions were also released (as was the case with WPL’s confidential, conditional and non binding offer for OSH via a scrip scheme of arrangement merger). Nonetheless, it would be fair to assume that the conditions would include the typical “no shop, no talk”, exclusivity, subject to financing and due diligence provisions. While the bidder appears well funded, any potentially clauses surrounding exclusivity could hamper ongoing asset sales over the extended due diligence process. Indeed, with the initial offer formed on limited public information (and possibly a management briefing) further due diligence would shed further light on STO’s contractual positions, remediation obligations, reserves quality or litigation liabilities (to name a few), with concerns over any combination of these factors derailing the process. With no guarantees surrounding a potential transaction post due diligence, agreeing to the offer would significantly narrow STO’s options and leave the company exposed if the transaction were to not complete. Indeed the A$6.88/sh offer price seemingly does incorporate the inherent risks hence the Board’s decision to reject the offer.  With indicative offers for asset-levels also likely received (with the press reporting that initial offers could be announced in early November), we believe that the Board’s decision to reject this offer not only reflects the opportunistic pricing terms, but also the level of interest that has been received regarding specific assets. In our recent note, STO - No assets are sacred, we highlighted those potential asset scenarios and how the residual business could look. With the industry willing to buy assets at the forward curve and with STO reportedly receiving plenty of interest in asset sales, we continue to see this as the more favourable option to expose the value of STO’s asset base. That said, if Scepter were to increase their offer by a mere 10% to ~A$7.58/sh, we believe such an offer could not as easily be dismissed as opportunistic by the STO Board (particularly if concessions were made surrounding specific conditions).

23 October 2015 2 Macquarie Research Santos

 At A$6.88/sh, we estimate this implies an oil price discounted by core and risked NAV of ~U$59/bbl and U$54/bbl, which compares to longer-term futures curve at U$64/bbl and our LT normalised assumption of U$80/bbl. Indeed STO also suggested that it did not reflect the "fair value of the asset base", let alone a premium for control. While offers for OSH would likely attract a premium vs. STO (given the differing quality of assets, growth prospects, balance sheet position, etc), a comparison of Scepter’s offer vs. WPL initial offer for OSH perhaps highlights the opportunistic nature of the Scepter proposal. Indeed we estimate that the pricing terms imply a 15-50% discount to WPL’s offer for OSH (based on 1 month VWAP prior to the disturbed price) based on various valuation metrics.

Fig 3 Scepter’s offer seemingly looks even more opportunistic than WPL’s offer for OSH, with the implied discount on various valuation metrics ranging from 15-50%. WPL/OSH Scepter/STO Discount

Oil price discounted U$/bbl ~U$65/bbl ~U$54/bbl (15.6%) 2017 EV/prod U$/kboepd $116,355 $99,512 (14.5%) 2017 EV/EBITDA x 7.0 x 4.9 x (29.7%) 2017 EV/EBIT x 13.0 x 9.2 x (29.6%) EV/1P U$/boe $26.7 $21.2 (20.4%) EV/2P U$/boe $20.1 $10.6 (47.1%) EV/2P+2C U$/boe $9.1 $4.5 (51.0%) Source: Macquarie Research, October 2015

Who is the bidder? The bidder, Scepter Partners, is a Bermuda-based merchant bank and direct investment syndicate for sovereign wealth led by the former Blackstone Advisor Partners Asian team. The group sponsors the acquisition of large cap strategic assets with a focus on natural resources, infrastructure, real estate and media/telecom (STO seems to tick two of these boxes).The core stakeholders include high net worth senior members of Asian and Gulf-based ruling families (reportedly include ruling families in Brunei and UAE). Scepter highlights that it invests with a long-term horizon, providing businesses with capital to realise growth potential – indeed STO are seemingly in need of both.  With funds only recently allocated to the bidding party from high net worth individuals we would expect that Scepter Partners remain keen to impress their key stakeholders with their foundation transaction. Furthermore, with the key stakeholders supporting Scepter well known (and publicised), we would suspect that management of Scepter (including Anthony Steains the current CEO) would be keen to highlight their transaction experience to these stakeholders. Consequently we do believe this is a creditable (albeit conditional) offer.  In mid-September the Board of Scepter stakeholders (led by HH Price Abdul Ali Kabier of Brunei) allocated U$14b of discretionary assets. Scepter also claim that its key stakeholders have net worth in excess of A$100bn, suggesting that the bidder is well funded. STO always screened as the most obvious takeover target In our recent note, Australian Energy Sector - The next M&A cycle set to commence, we painted a picture of growing M&A against the backdrop of lower-for-longer oil prices. While we did not necessarily believe that any of the locally listed large-cap E&P stocks were takeover targets in their own right, we have now seen offers for two of the three stocks, namely STO and OSH. That said we have always screened STO as the most obvious takeover target from a valuation perspective, albeit there were stock specific challenges (namely the long-tail of assets).

23 October 2015 3 Macquarie Research Santos

Fig 4 Adopting average EV/2P transaction metrics for gas-weighted assets over the last 5 years and adjusting for sunk development costs, STO screened as the only possible takeover target WPL STO OSH Market EV/2P US$/bbl $8.26 $8.26 $8.26 5 year average of global gas focused transactions Developed EA gas mmboe 136 EV/2P U$/boe $10.00 Developed reserves justify slight premium Undeveloped EA gas mmboe 344 EV/2P U$/boe $2.07 25% of global avg EV/2P multiple Enterprise Value US$bn $0.00 $2.07 $0.00 Developed 2P Reserves mmboe 761 510 411 EV/2P U$/boe $14.46 $14.46 $14.46 Average capital intensity of Pluto, PNG LNG Undeveloped 2P Reserves mmboe 577 256 132 EV/2P U$/boe $8.26 $8.26 $8.26 5 year average of global gas focused transactions Enterprise Value US$bn $15.77 $9.48 $7.04 2C Resources mmboe 1,743 1,424 770 EV/2C U$/boe $1.65 $1.65 $1.65 20% of global avg EV/2P multiple Enterprise Value US$bn $2.88 $2.35 $1.27 Total Enterprise Value US$bn $18.65 $13.91 $8.31 Net Debt $3.82 $5.95 -$0.77 Excludes project financing for PNG LNG Implied Market Cap A$ps $18.09 $11.01 $11.07 Issued shares 824 1,009 1,523 Implied share price $21.96 $10.91 $7.27 Premium to current share price -29% 73% -2% Source: Macquarie Research, October 2015

 Adopting average transaction metrics for gas-weighted transactions over the last five years and making adjustments for the developed reserves base we estimate that the average implied takeover premium vs. current share prices for Australian Energy stocks is merely 14% - barely enough to build in a control premium. Indeed, as has historically been the case, STO appears the only plausible takeover with the implied takeover price 70% above the current share price.  STO continues to have a long-tail of assets which has historically dissuaded potential suitors attracted to specific assets. However, with the offer price ascribing value for only STO’s five most valuable assets under Macquarie assumptions (but closer to 20 assets under the forward curve) and with the A&D market becoming more liquid, a risk-seeking buyer (such as Scepter) could back itself to restructure STO’s portfolio (whether it be through asset sales or carve-outs), leaving it with the most valuable assets.

Fig 5 STO has the largest portion of undeveloped Fig 6 While STO has a long-tail of assets, the most reserves and largest resource-to-reserves ratio valuable 8 assets underpin the current enterprise value

2P+2C (mmboe) Developed 2P Undeveloped 2P 2C Enterprise Value (A$m) NAV @ MRE assumptions 3,500 NAV @ Forward Curve 20,000 Offer EV 3,000 18,000 16,000 2,500 14,000 12,000 2,000 10,000

1,500 8,000 6,000 1,000 4,000 2,000 500 0

0

Spar

LNG

GLNG Kipper

WPL STO OSH Darwin

Cooper

Reindeer ChimSao LNGPNG Source: Company Data, Macquarie Research, August 2015 Source: Macquarie Research, August 2015

23 October 2015 4 Macquarie Research Santos

Asset sales still the preferred option With indicative offers for asset-levels also likely received (with the press reporting that initial offers could be announced in early November), we believe that the Board’s decision to reject this offer not only reflects the opportunistic pricing terms, but also the level of interest that has been received regarding specific assets. In our recent note, STO - No assets are sacred, we highlighted those potential asset scenarios and how the residual business could look. With the industry willing to buy assets at the forward curve and with STO reportedly receiving plenty of interest in asset sales, we continue to see this as the more favourable option to expose the value of STO’s asset base.  Focusing on NAV and FCF yields even adjusting for the additional equity required in instances where there is a funding shortfall, we estimate that the implied TERP is at up to a 9% discount to post asset sale/equity raising core NAV or 25% discount to risked NAV, with a sale of PNG LNG delivering the largest discount. Nonetheless a sale of the highest margin businesses (PNG LNG and WA&NT) hits 2017 FCF yields, despite the limited additional equity required with 2017 yields falling to 11.3% and 10.6% respectively

Fig 7 Assuming each asset sale in isolation (and any Fig 8 However minimising the requirement for equity equity issuance to resolve the shortfall) we estimate the through asset sales comes at a cost in term of FCF TERP is still at up to a 25% discount to our post asset yields (albeit with STO still offering healthy yields on a sale/equity issuance risked NAV post asset sale & post money basis)

18% STO NAV (A$/sh) Core NAV % Post asset sale and equity raising FCF Yield (based on TERP) 9 0% 2016 2017 Risked NAV 16% 14.5% 9 TERP discount to Core NAV [RHS] -5% 14% 12.8% 8 12.2% 12% 11.3% 8 10.6% -10% 7 10%

7 -15% 8% 6 6% -20% 6 3.4% 4% 2.8% 5 -25% 1.4% 1.6% 5 2% 0.3% 4 -30% 0% Base Case PNG LNG WA / NT Moomba SE Asia GLNG PNG LNG WA / NT sale Moomba sale SE Asia sale GLNG (A$2bn sale sale sale sale pipeline sale pipeline sale raise) sale Source: Macquarie Research, October 2015 Source: Macquarie Research, October 2015  Sale of producing assets will have an obvious impact on pro-forma production, EBITDA, NPAT and FCF. While this could rebase the size of the business lower, as the executive chairman Peter Coates has articulated, the focus of the strategic review is to “restore and maximise shareholder value” not preserve production for the sake of maximising the scale of the business. Indeed we would argue that the market is far more focused on STO’s balance sheet and preserving the value of the asset base, rather than retaining a production base.

Fig 9 Assuming assets sales and a shortfall raising the STO business will look difference, however the focus should remain on the balance sheet and value creation, not necessarily headline production and earnings 2017 forecasts Base Moomba SE Asia (ex PNG LNG WA&NT GLNG pipeline Case (A$2bn infrastructure PNG LNG) sale sale sale raising) sale sale Production mmboe 67.4 56.4 51.9 67.7 62.5 67.7 Sales mmboe 75.7 67.7 62.7 78.2 73.0 78.2

Revenue A$m 4,072 3,369 3,338 4,092 3,840 4,096 EBITDA A$m 2,474 1,942 1,955 2,395 2,303 2,448 EBIT A$m 1,028 695 723 943 923 996 NPAT A$m 467 320 289 417 405 447 EPS Acps 29 29 25 32 31 31 Operating Cash Flow A$m 2,293 1,879 1,796 2,225 2,100 2,265 Free Cash Flow A$m 1,156 777 773 1,201 1,019 1,152

EV/EBITDA x 7.2 x 7.1 x 7.3 x 6.3 x 6.6 x 6.4 x PER x 21.5 x 21.6 x 25.4 x 19.9 x 20.7 x 20.3 x FCF Yield % 11.6% 11.3% 10.6% 14.5% 12.2% 12.8% * Forecasts assume the forward curve and spot fx. Based upon TERP assuming a the equity shortfall is raised at a 30% discount to closing price on 22 Oct(A$6.32/sh) Source: Macquarie Research, September 2015

23 October 2015 5 Macquarie Research Santos

Fig 10 Santos financials

Santos (STO-AU) Share Price: A$6.32 Outperform Shares: 1004.4m

Profit & Loss 1H15A 2H15E 2014A 2015E 2016E 2017E Price Assumptions 1H15A 2H15E 2014A 2015E 2016E 2017E Sales revenue A$m 1,611 1,711 4,037 3,322 4,245 4,904 US$/A$ ¢ 0.77 0.69 0.89 0.73 0.63 0.67 add other income A$m 44 43 81 87 81 76 Domestic gas A$/GJ 4.00 4.44 3.53 4.22 6.52 6.97 Total revenue A$m 1,655 1,753 4,118 3,408 4,326 4,980 Oil-Brent US$/bbl 57.53 52.00 100.08 54.76 58.25 67.00 less operating costs A$m (717) (829) (2,029) (1,546) (1,749) (1,825) EBITDAX A$m 938 924 2,089 1,862 2,577 3,155 Production 1H15A 2H15E 2014A 2015E 2016E 2017E less exploration expensed A$m (194) (90) (256) (284) (136) (140) Natural gas PJ 88.6 90.3 178.8 178.8 181.9 183.0 EBITDA A$m 744 834 1,833 1,578 2,441 3,015 Crude mmbbl 3.8 4.2 9.6 8.1 6.8 5.9 less dep. & amort. A$m (480) (543) (988) (1,023) (1,225) (1,320) Condensate mmbbl 1.9 2.0 3.2 3.9 3.9 3.9 less other non-cash costs A$m (13) - - (13) - - LPG k tonnes 74.3 91.3 167.4 165.6 180.0 183.9 EBIT A$m 251 291 845 542 1,217 1,695 LNG k tonnes 660.7 704.7 826.7 1365.4 1926.3 2367.7 less net interest A$m (125) (149) (97) (274) (444) (369) Total production mmboe 29.1 28.4 54.1 58.4 63.3 67.4 Pre-tax operating profit A$m 126 142 748 268 772 1,325 Third party sales mmboe 6.5 4.4 12.5 8.4 11.7 12.8 less tax expense (incl PRRT) A$m (94) (52) (215) (146) (286) (441) Total sales mmboe 34.8 31.0 63.7 64.8 70.8 75.7 Net operating profit A$m 32 90 533 122 486 884 80 mmboe Gas Crude Condensate LPG LNG add non-recurring items A$m 5 - (1,468) 5 - - 70 Reported profit A$m 37 90 (935) 127 486 884 60 add (goodw ill amm - pref div) A$m ------Adjusted profit A$m 32 90 533 122 486 884 50 0% 0% 0% 40 EPS (Adjusted) Acps 3.3 9.0 54.7 12.3 46.1 80.1 30 EPS Grow th % -88% 177% 5% -78% 276% 74% 20 10 DPS (Ordinary & Special) Acps 15 15 35 30 32 35 0

Franking % 100% 100% 100% 100% 100% 100%

2003 2005 2007 2001 2002 2004 2006 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 EFPOWA shares on issue m 984 1,004 975 994 1,050 1,103 2000

Cashflow Analysis 1H15A 2H15E 2014A 2015E 2016E 2017E Reserves 2014A 2015E 2016E 2017E Cash receipts from operations A$m 1,825 1,754 4,577 3,579 4,318 5,172 Natural gas PJ 6,786 6,607 6,425 6,242 less operating costs A$m (1,031) (833) (2,371) (1,864) (2,217) (1,771) Oil mmbbl 62 54 47 41 less gross interest paid A$m (83) (126) (49) (209) (389) (321) Condensate mmbbl 63 59 55 51 less tax paid A$m (77) (34) (164) (111) (111) (163) LPG k tonnes 3,022 2,856 2,676 2,492 Cashflow from operations A$m 634 761 1,993 1,395 1,601 2,917 Total 2P reserves mmboe 1,245 1,186 1,123 1,056 less development & exploration A$m (1,288) (1,160) (3,714) (2,448) (1,051) (1,138) Contingent resources mmbbl 1,721 1,721 1,721 1,721 less acq./inv. A$m (125) - (48) (125) - - Total reserves & resources mmboe 2,966 2,907 2,844 2,777 add divestment A$m 47 45 1 92 - - less dividends paid A$m (107) (151) (196) (258) (315) (364) 2P reserve life years 23.1 20.3 17.7 15.7 add debt movements A$m 334 27 2,081 361 (150) (1,765) EV/ 1P reserves A$/boe 22.20 24.50 27.60 31.88 add equity movements/other A$m 106 151 10 257 315 364 EV / 2P reserves A$/boe 11.11 11.65 12.31 13.10 Net cashflow A$m (399) (327) 127 (726) 400 14 EV / Total resources A$/boe 4.66 4.76 4.86 4.98 add exchange rate adj. A$m 23 - 4 23 - - EV/ 1P reserves US$/boe 17.32 19.11 21.52 24.87 Increase in cash A$m (376) (327) 131 (703) 400 14 EV / 2P reserves US$/boe 8.66 9.09 9.60 10.21 Net debt at year end A$m 8,600 10,421 7,477 10,421 9,952 7,355 EV / Total resources US$/boe 3.64 3.71 3.79 3.88

Balance Sheet 1H15A 2H15E 2014A 2015E 2016E 2017E Per Barrel Statistics 1H15A 2H15E 2014A 2015E 2016E 2017E Cash & cash eq. A$m 399 72 775 72 472 486 Sales revenue / boe US$/boe 56.63 57.04 66.44 41.31 42.43 48.95 Current assets A$m 1,662 1,340 2,065 1,340 1,751 1,582 EBIT / boe US$/boe 8.82 9.71 13.91 6.74 12.16 16.92 Fixed assets A$m 21,851 22,417 20,280 22,417 22,106 21,743 Profit / boe US$/boe 1.12 3.01 8.77 1.52 4.86 8.82 Total assets A$m 23,513 23,757 22,345 23,757 23,857 23,325 Opex/boe US$/boe 11.92 11.10 16.44 11.53 9.40 9.22 Current liabilities A$m 1,578 1,395 1,946 1,395 2,563 2,553 Capex/boe US$/boe 34.67 26.61 61.13 30.45 10.50 11.36 Total liabilities A$m 13,800 15,336 12,932 15,336 15,032 12,840 DDA/boe US$/boe 16.62 17.87 16.26 12.54 12.09 13.04 Shareholder equity A$m 9,713 8,421 9,413 8,421 8,824 10,485 Cash flow /boe US$/boe 22.29 25.37 32.80 17.35 16.00 29.12

Ratio Analysis 1H15A 2H15E 2014A 2015E 2016E 2017E NPV @ WACC of 9.0% ND/ND+E % 47% 55% 44% 55% 53% 41% Producing assets A$m A$ps % Interest cover x 2.1 x 2.5 x 8.7 x 2.0 x 2.7 x 4.6 x Cooper Basin Area 2,647 2.62 Dividend payout ratio % 461% 167% -37% 235% 68% 43% Onshore Queensland CSG Assets 79 0.08 ROA % 1% 1% 4% 2% 5% 7% Otw ay Gas 245 0.24 ROE % 0% 1% 5% 1% 6% 9% WA Gas 1,484 1.47 ROIC % 0% 0% 4% 2% 4% 6% WA Oil 522 0.52 Effective tax rate % 76% 33% 34% 53% 32% 31% South East Asia 868 0.86 EBITDA margin % 46% 49% 45% 48% 58% 61% Bayu-Undan 376 0.37 EBIT margin % 16% 17% 21% 16% 29% 35% PNG LNG trains 1 & 2 risked valuation @ 100% 2,964 2.94 Free cash flow A$m (607) (354) (1,720) (961) 550 1,779 Developing assets Kipper risked valuation @ 100% 634 0.63 Valuation 1H15A 2H15E 2014A 2015E 2016E 2017E Glastone LNG train 1&2 risked valuation @ 100% 5,262 5.21 EV/EBITDAX ratio x 17.4 x 15.0 x 6.6 x 7.4 x 5.4 x 4.4 x Cooper Basin - 2C risked valuation @ 50% 509 0.50 EV/DACF ratio x 22.4 x 18.0 x 7.6 x 9.2 x 7.0 x 5.6 x PNG LNG debottleneck risked valuation @ 75% 124 0.12 P/E ratio x 242.2 x 70.2 x 11.6 x 51.6 x 13.7 x 7.9 x Static assets & exploration P/CFPS ratio x 22.0 x 17.5 x 3.5 x 4.4 x 3.6 x 3.0 x PNG LNG train 3 risked valuation @ 75% 449 0.45 FCF yield % nmf nmf nmf nmf 8.2% 25.6% Discoveries 687 0.68 Dividend yield % 1.9% 2.4% 5.5% 4.7% 5.0% 5.5% Exploration 990 0.98 Financial assets Sensitivities (Adjusted Earnings) Valuation 2014A 2015E 2016E 2017E Corporate/tariffs/other 185 0.18 Oil price (+US$1/bbl) A$m 12.11 533 144 524 942 Cash & Investments 444 0.44 delta 0.15 0 21 38 58 Debt (6,395) (6.34) 1.3% 0.0% 17.5% 7.8% 6.6% Risked NPV 12,074 11.96 Currency (+1c) A$m 11.69 533 122 469 871 Shareprice prem/(disc) to NPV -47% delta (0.27) 0 (0) (17) (13) - core NPV per share (A$) 10.03 -2.3% 0.0% -0.4% -1.7% -1.2% - risked NPV per share (A$) 11.96 - unrisked NPV per share (A$) 15.34

Source: Company data, Macquarie Research, October 2015

23 October 2015 6 Macquarie Research Santos

Fig 11 Santos NAV breakdown

Producing Assets Interest Unrisked Unrisked Risk Risked Risked USD/boe A$ps A$ps % NPV Sensitivity mmmboe AUD (m) mmmboe AUD (m) risked unrisked -$10 Base +$10 Cooper Basin - 2P 63.0% 212 2,647 100% 212 2,647 9.4 2.62 2.62 22% 1.38 2.62 2.33 Surat / Denison various 6 68 100% 6 68 8.9 0.07 0.07 1% 0.08 0.07 0.08 Fairview 30.0% 1 11 100% 1 11 11.0 0.01 0.01 0% - 0.01 - Casino & Henry 50.0% 16 224 100% 16 224 10.8 0.22 0.22 2% 0.25 0.22 0.25 Minerva 10.0% 2 21 100% 2 21 6.5 0.02 0.02 0% 0.02 0.02 0.02 Bayu-Undan 11.5% 19 376 100% 19 376 14.6 0.37 0.37 3% 0.29 0.37 0.48 John Brookes 45.0% 47 328 100% 47 328 5.3 0.33 0.33 3% 0.27 0.33 0.28 Spar/Halyard (Aus) 45.0% 32 409 100% 32 409 9.6 0.41 0.41 3% 0.49 0.41 0.52 Reindeer/Carabou 45.0% 35 746 100% 35 746 15.9 0.74 0.74 6% 0.74 0.74 0.96 Barrow Island 28.6% 4 141 100% 4 141 26.9 0.14 0.14 1% 0.12 0.14 0.16 Stag 66.7% 6 238 100% 6 238 27.6 0.24 0.24 2% 0.20 0.24 0.28 Mutineer / Exeter 41.6% 1 30 100% 1 30 32.6 0.03 0.03 0% 0.02 0.03 0.03 Fletcher/Finucane 44.0% 3 113 100% 3 113 26.7 0.11 0.11 1% 0.08 0.11 0.12 Maleo & Peluang 67.5% 6 194 100% 6 194 26.5 0.19 0.19 2% 0.22 0.19 0.22 SE Gobe 9.4% 0 6 100% 0 6 27.4 0.01 0.01 0% 0.00 0.01 0.01 Chim Sao & Dua (Vietnam) 31.9% 13 599 100% 13 599 35.2 0.59 0.59 5% 0.56 0.59 0.79 Oyong & Wortel 45.0% 6 69 100% 6 69 9.3 0.07 0.07 1% 0.07 0.07 0.07 PNG LNG trains 1 & 2 13.5% 234 2,964 100% 234 2,964 9.5 2.94 2.94 25% 2.25 2.94 3.42 Sub Total 642 9,185 642 9,185 10.7 9.10 9.10 76% 7.04 9.10 10.04

Developing Assets Gladstone LNG train 1&2 30.0% 451 5,262 100% 451 5,262 8.7 5.21 5.21 44% 3.64 5.21 5.43 PNG LNG debottleneck 13.5% 1 166 75% 0 124 239.6 0.12 0.16 1% 0.24 0.12 0.29 Kipper 35.0% 45 634 100% 45 634 10.6 0.63 0.63 5% 0.63 0.63 0.67 Cooper Basin - 2C 63.0% 212 1,017 50% 106 509 3.6 0.50 1.01 4% 0.00 0.50 0.37 Mereenie - 2P 50.0% 14 149 100% 14 149 8.2 0.15 0.15 1% 0.14 0.15 0.16 Gunnedah Basin (2P) 80.0% 133 736 20% 27 147 4.2 0.15 0.73 1% 0.16 0.15 0.16 Sub Total 855 7,964 643 6,825 8.0 6.76 7.89 57% 4.81 6.76 7.08

Static Assets PNG LNG expansion train(s) 11.5% 66 599 75% 49 449 6.8 0.45 0.59 4% 0.37 0.45 0.54 Ande Ande Lumut - K-sand 50.0% 51 121 75% 38 91 7.4 0.09 0.12 1% 0.04 0.09 0.12 Sole - 2C 50.0% 18 30 75% 14 22 8.3 0.02 0.03 0% 0.04 0.02 0.04 Mereenie - 2C 50.0% 14 115 15% 2 17 6.4 0.02 0.11 0% 0.02 0.02 0.02 Caldita/Barossa 25.0% 125 666 30% 38 200 4.0 0.20 0.66 2% 0.09 0.20 0.28 Petrel/Tern 40.0% 152 202 30% 46 61 1.0 0.06 0.20 1% 0.06 0.06 0.06 Sub Total 273 1,530 141 779 4.2 0.83 1.52 6% 0.56 0.77 1.00

Exploration Zola (Contingent) 24.8% 21 56 50% 10 28 3.0 0.03 0.06 0% 0.03 0.03 0.03 Bianchi (Prospective) 24.8% 12 20 50% 6 10 3.0 0.01 0.02 0% 0.01 0.01 0.01 Zola (Prospective) 24.8% 84 309 20% 17 62 3.0 0.06 0.31 1% 0.06 0.06 0.06 Burnside-1 (Aus) 47.8% 120 268 25% 30 67 2.0 0.07 0.27 1% 0.06 0.07 0.06 Winchester-1 (Aus) 75.0% 167 728 50% 83 364 3.5 0.36 0.72 3% 0.33 0.36 0.33 Crow n-1 (Aus) 30.0% 118 284 50% 59 142 2.0 0.14 0.28 1% 0.13 0.14 0.13 Lasseter-1 (Aus) 30.0% 144 353 50% 72 176 2.0 0.17 0.35 1% 0.16 0.17 0.16 Bestari-1 Block R PSC (Malay) 20.0% 40 245 50% 20 123 5.0 0.12 0.24 1% 0.11 0.12 0.11 Gunnedah Basin (2C) 50.0% 108 233 5% 5 12 1.8 0.01 0.23 0% 0.01 0.01 0.01 Cooper Basin - Shale 63.0% 26 69 10% 3 7 2.0 0.01 0.07 0% 0.01 0.01 0.01 Sub total 840 2,565 306 990 2.4 0.98 2.54 8% 0.82 0.98 0.82

Financial & Corporate Cash & investments 444 0.44 0.44 4% 0.81 0.44 0.81 Debt & hybrid (6,395) (6.34) (6.34) -53% (5.92) (6.34) (5.92) Base business carbon - - - 0% - - - LNG projects carbon - - - - 0% - - - ORR, Tariffs 440 0.44 0.44 4% 0.44 0.44 0.44 Third Party Sales 189 0.19 0.19 2% 0.25 0.19 0.25 Corporate overheads (445) (0.44) (0.44) -4% (0.50) (0.44) (0.50) Sub Total (5,767) (5.71) (5.71) -48% (4.92) (5.71) (4.92) Overall total 2,610 mmboe 12,013 AUDm 11.96 15.34 99% 8.36 11.96 14.07 -core NPV per share (A$) 833 10.03 6.69 10.03 11.91 -risked NPV per share (A$) 1,731 11.96 8.36 11.96 14.07 -unrisked NPV per share (A$) 2,610 15.34 11.86 15.34 18.47

Diluted number of shares (m) 1,009.3 Ordinary Shares on Issue (m) 1,004.4 In-the-money options outstanding (m) 4.9 Exchange Rate 0.75 WACC (post tax) 9.0% Share Price 6.32 Price premium (discount) to NPV -47% Proportion of NAV from LNG 75% Franking credits (risked at 50% - A$ps) 0.40 Source: Macquarie Research, October 2015

23 October 2015 7 Macquarie Research Santos Macquarie Quant View

The quant model currently holds a strong negative view on Santos. The Attractive Displays where the strongest style exposure is Growth, indicating this stock has good historic company’s ranked based on

and/or forecast growth. Growth metrics focus on both top and bottom line s

l the fundamental consensus a items. The weakest style exposure is Price Momentum, indicating this t

n Price Target and stock has had weak medium to long term returns which often persist into e Macquarie’s Quantitative the future. m

a

Alpha model.

d n

536/574 u Two rankings: Local market F (Australia & NZ) and Global Global rank in sector (Energy) Energy Quant % of BUY recommendations 62% (8/13) Local market rank Global sector rank Number of Price Target downgrades 6 Number of Price Target upgrades 1

Macquarie Alpha Model ranking Factors driving the Alpha Model A list of comparable companies and their Macquarie Alpha model score For the comparable firms this chart shows the key underlying styles and their (higher is better). contribution to the current overall Alpha score.

Caltex Australia 0.3 Caltex Australia

Woodside Petroleum -0.3 Woodside Petroleum

Oil Search -0.9 Oil Search

WorleyParsons -1.3 WorleyParsons

Santos -2.6 Santos

Beach Energy -2.7 Beach Energy

-100% -80% -60% -40% -20% 0% 20% 40% 60% 80% 100% -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 Valuations Growth Profitability Earnings Price Quality Momentum Momentum

Macquarie Earnings Sentiment Indicator Drivers of Stock Return The Macquarie Sentiment Indicator is an enhanced earnings revisions Breakdown of 1 year total return (local currency) into returns from dividends, changes signal that favours analysts who have more timely and higher conviction in forward earnings estimates and the resulting change in earnings multiple. revisions. Current score shown below.

Caltex Australia Caltex Australia 0.6 Woodside Petroleum Woodside Petroleum -0.2 Oil Search Oil Search -0.7 WorleyParsons WorleyParsons -0.5 Santos Santos -1.0

Beach Energy -0.6 Beach Energy

-3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 -70% -50% -30% -10% 10% 30% 50% 70% Dividend Return Multiple Return Earnings Outlook 1Yr Total Return

What drove this Company in the last 5 years How it looks on the Alpha model Which factor score has had the greatest correlation with the company’s A more granular view of the underlying style scores that drive the alpha (higher is returns over the last 5 years. better) and the percentile rank relative to the sector and market. ⇐ Negatives Positives ⇒ Normalized Percentile relative Percentile relative EV/EBITDA FY0 34% Score to sector(/574) to market(/395) Alpha Model Score -2.59 Interest Cover 32% Valuation -1.09 EPS Growth 5yr Historic 31% Growth -0.03 Operating Margin NTM 31% Profitability -0.41 Earnings Momentum -0.41 EPS Growth FY1 -20% Price Momentum -1.62 Operating Leverage Inc. -21% Quality -0.73 Capital & Funding 0.01 PEG Ratio Inverted -31% Liquidity -1.19 Operating Leverage NTM -31% Risk -1.40 Technicals & Trading -0.11 -40% -20% 0% 20% 40% 0 50 100 0 50 100 0 0 1 1

Source (all charts): FactSet, Thomson Reuters, and Macquarie Research. For more details on the Macquarie Alpha model or for more customised analysis and screens, please contact the Macquarie Global Quantitative/Custom Products Group ([email protected])

23 October 2015 8 Macquarie Research Santos

Important disclosures: Recommendation definitions Volatility index definition* Financial definitions Macquarie - Australia/New Zealand This is calculated from the volatility of historical All "Adjusted" data items have had the following Outperform – return >3% in excess of benchmark return price movements. adjustments made: Neutral – return within 3% of benchmark return Added back: goodwill amortisation, provision for Underperform – return >3% below benchmark return Very high–highest risk – Stock should be catastrophe reserves, IFRS derivatives & hedging, expected to move up or down 60–100% in a year IFRS impairments & IFRS interest expense Benchmark return is determined by long term nominal – investors should be aware this stock is highly Excluded: non recurring items, asset revals, property GDP growth plus 12 month forward market dividend speculative. revals, appraisal value uplift, preference dividends & yield minority interests Macquarie – Asia/Europe High – stock should be expected to move up or Outperform – expected return >+10% down at least 40–60% in a year – investors should EPS = adjusted net profit / efpowa* Neutral – expected return from -10% to +10% be aware this stock could be speculative. ROA = adjusted ebit / average total assets Underperform – expected return <-10% ROA Banks/Insurance = adjusted net profit /average Medium – stock should be expected to move up total assets Macquarie First South - South Africa or down at least 30–40% in a year. ROE = adjusted net profit / average shareholders funds Outperform – expected return >+10% Gross cashflow = adjusted net profit + depreciation Neutral – expected return from -10% to +10% Low–medium – stock should be expected to *equivalent fully paid ordinary weighted average Underperform – expected return <-10% move up or down at least 25–30% in a year. number of shares Macquarie - Canada Outperform – return >5% in excess of benchmark return Low – stock should be expected to move up or All Reported numbers for Australian/NZ listed stocks Neutral – return within 5% of benchmark return down at least 15–25% in a year. are modelled under IFRS (International Financial Underperform – return >5% below benchmark return * Applicable to Asia/Australian/NZ/Canada stocks Reporting Standards). only Macquarie - USA Outperform (Buy) – return >5% in excess of Russell Recommendations – 12 months 3000 index return Note: Quant recommendations may differ from Neutral (Hold) – return within 5% of Russell 3000 index Fundamental Analyst recommendations return Underperform (Sell)– return >5% below Russell 3000 index return

Recommendation proportions – For quarter ending 30 September 2015 AU/NZ Asia RSA USA CA EUR Outperform 48.87% 59.96% 35.63% 42.13% 59.44% 42.11% (for US coverage by MCUSA, 3.54% of stocks followed are investment banking clients) Neutral 33.44% 25.00% 39.08% 52.55% 37.06% 38.42% (for US coverage by MCUSA, 5.05% of stocks followed are investment banking clients) Underperform 17.68% 15.04% 25.29% 5.32% 3.50% 19.47% (for US coverage by MCUSA, 0.51% of stocks followed are investment banking clients)

STO AU vs ASX 100, & rec history

(all figures in AUD currency unless noted)

Note: Recommendation timeline – if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, October 2015

12-month target price methodology STO AU: A$7.50 based on a DCF methodology

Company-specific disclosures: STO AU: Macquarie and its affiliates collectively and beneficially own or control 1% or more of any class of Santos Limited's equity securities. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures.

Date Stock Code (BBG code) Recommendation Target Price 09-Sep-2015 STO AU Outperform A$7.50 14-Aug-2015 STO AU Outperform A$9.00 15-Apr-2015 STO AU Outperform A$10.00 09-Mar-2015 STO AU Outperform A$11.00 09-Dec-2014 STO AU Outperform A$12.00 02-Dec-2014 STO AU Outperform A$14.50 08-Oct-2014 STO AU Outperform A$15.50 27-Jun-2014 STO AU Outperform A$17.00 16-May-2014 STO AU Outperform A$16.50 16-Aug-2013 STO AU Outperform A$17.00 23-Feb-2013 STO AU Outperform A$16.50

Target price risk disclosures: STO AU: Any inability to compete successfully in their markets may harm the business. This could be a result of many factors which may include geographic mix and introduction of improved products or service offerings by competitors. The results of operations may be materially affected by global economic conditions generally, including conditions in financial markets. The company is exposed to market risks, such as changes in interest rates, foreign exchange rates and input prices. From time to time, the company will enter into transactions, including transactions in derivative instruments, to manage certain of these exposures.

Analyst certification: We hereby certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. The Analysts responsible for preparing this report receive compensation from Macquarie that is based upon various factors including Macquarie Group Ltd total revenues, a portion of which are generated by Macquarie Group’s Investment Banking activities. 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23 October 2015 10 Macquarie Research Santos

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Head of Equity Research Resources Quantitative Peter Redhead (Global) (852) 3922 4836 Hayden Bairstow (618) 9224 0838 Gurvinder Brar (Global) (44 20) 3037 4036 Paul Checchin (Australia & NZ) (612) 8232 4197 Ben Crowley (618) 9224 0839 John Conomos (Australia) (612) 8232 5157 Andrew Hodge (612) 8237 0321 Jeremy Lamplaugh (612) 8232 1060 Retail / Consumer / Food & Bev Bryan Raymond (612) 8232 2740 Real Estate Data Services Paul Checchin (612) 8232 4197 Sheridan Duffy (612) 8232 9786 Energy Rob Freeman (612) 8237 1152 Kirit Hira (612) 8232 9692 Economics and Strategy Telcos / Media / Tourism & Leisure Jason Todd (612) 8237 3134 ESG Andrew Levy (612) 8232 5165 James McIntyre (Australia) (612) 8232 8930 Deana Mitchell (612) 8232 4576 Andrew Russell (612) 8232 9390 Financials Utilities Find our research at Macquarie: www.macquarie.com.au/research Banks Ian Myles (612) 8232 4157 Thomson: www.thomson.com/financial Brendan Carrig (612) 8237 6043 Commodities & Precious Metals Reuters: www.knowledge.reuters.com Anita Stanley (Maternity leave) (612) 8232 9869 Bloomberg: MAC GO Insurance & Diversified Financials Colin Hamilton (Global) (44 20) 3037 4061 Jim Lennon (London) (44 20) 3037 4271 Factset: http://www.factset.com/home.aspx Tim Lawson (612) 8237 7332 CapitalIQ www.capitaliq.com Bryan Raymond (612) 8232 2740 New Zealand Contact Gareth Warfield for access (612) 8232 3207 Andrew Buncombe (612) 8232 0629 Stephen Hudson (649) 363 1414 Healthcare Warren Doak (649) 363 1416 See and hear our analysts at Daniel Frost (649) 363 1474 www.macquarie.com.au/macquariedigital Dr Craig Collie (612) 8232 4130 Nick Mar (649) 363 1476 Industrials Andrew Levy (Telecommunications) (612) 8232 5165 Toll free from overseas Capital Goods Emerging Leaders – Industrials Canada 1800 989 8159 Hong Kong 800 96 2049 John Purtell (612) 8232 8633 Adam Simpson (612) 8232 4439 Niraj Shah (612) 8237 0750 Japan 0053 161 6437 Andrew Wackett (618) 9224 0867 New York 1888 622 7862 Infrastructure Jodie Bannan (612) 8232 2999 Singapore 800 616 1037 Ian Myles (612) 8232 4157 Jennifer Kruk (612) 8232 6422 Transportation Michael Higgins (612) 8232 3208 Email addresses Sam Dobson (612) 8232 9986 [email protected]

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Sales Equities Sales Trading Specialist Sales Dan Ritchie (Australia) (612) 8232 3124 Ben Clifford (Head of Sales Trading) (612) 8232 4012 Julia Thomas (Property) (613) 9635 9323 Dave Roberton (New Zealand) (649) 363 1498 Sam Molina (Sydney) (612) 8232 5935 Phil Zammit (Emerging Leaders) (612) 8232 3122 John Ogle (Sydney) (612) 8232 3118 Owen Johnston (Emerging Leaders) (612) 8232 3328 Sales Francis Sarks (Sydney) (612) 8232 4458 Alternative Strategies Kristen Edmond Antony Kirwan (Sydney) (612) 8232 4003 (Desk Head – Sydney) (612) 8232 3111 Ben McIntyre (Sydney) (612) 8237 2833 Greg Mann (Equity Finance) (612) 8232 1820 Gavin Maher (Australia) (612) 8232 4151 Philip Sellaroli (Sydney) (612) 8232 2029 Shannon Donohoe (Stock Borrow & Loan) (612) 8232 6997 Nick Rehak (Australia) (612) 8232 4053 John Alessi (Melbourne) (613) 9635 9183 Charlotte Edelman (Australia) (612) 8232 4565 Andrew Donald (Melbourne) (613) 9635 8270 Syndication Kurt Dalton (Australia) (612) 8232 5943 Natalie Rachele (Melbourne) (613) 9635 8595 Paul Staines (612) 8232 7781 Mike Johnson (Desk Head – Jon Holland (Auckland) (649) 363 1471 Angus Firth (612) 8232 4039 Hong Kong & International Sales) (852) 3922 2050 Mike Keen (London) (44 20) 3037 4905 Tiffany Ward (612) 8232 5151 Adam Millhouse (Hong Kong) (852) 3922 2055 Electronic Execution Dan Pittorino (Desk Head - London) (44 20) 3037 4831 Corporate Access Valerie Kingsmill (612) 8237 2230 Andrew Haigh (London) (44 20) 3037 4843 Julie Loring (612) 8232 7543 Darren Miller (612) 8232 8261 Clare McCartney (London) (44 20) 3037 4833 Asha Walsh (612) 8237 8464 James Giarratano (612) 8237 0878 Brendan Waller Transition Management & Portfolio (Desk Head - Melbourne) (613) 9635 8177 Portfolio Trading Solutions Leighton Patrick Garth Leslie (612) 8232 9982 (Desk Head - New York) (1 212) 231 2552 Mick Larkin (612) 8232 0639 Kathryn Koutouzis (612) 8237 5456 Rowly Hirst (New York) (1 212) 231 2553 David Goodman (612) 8232 5245 Michael McNair (New York) (1 212) 231 2571 Block Trading Scott Macaulay (612) 8232 4782 Tim Shaw (Desk Head – Sydney). (612) 8232 4386