Royal Dutch Shell plc.; market cap (as of 17/04/15): $200.1bn

BG Group plc.; market cap (as of 17/04/15): $61.1bn

 

Introduction

On Wednesday 8, Royal Dutch Shell announced the acquisition of BG Group for $70.1bn for a mix of cash and stock, which would make Shell the largest producer of liquefied natural gas in the world.

 

About Shell

Royal Dutch Shell plc. (Shell) is a centenary independent Anglo-Dutch multinational oil and gas corporation incorporated in the United Kingdom but headquartered in Netherlands. Besides being the world’s 4th largest company by revenue, Shell is also the largest publicly traded company by market capitalization on the London Stock Exchange. It operates through Upstream and Downstream segments. The first regards the exploring and extraction of crude oil, natural gas, and natural gas liquids. Downstream segments refers instead to the conversion of natural gas to liquids to provide fuels and other products, but also distribution, marketing and trading of a wide range of products, among which crude oil and petrochemicals. The company operates through the interaction of 94,000 employees in more than 70 countries, holding interests in 24 refineries.

 

About BG

Founded in 1997, BG Group plc. (BG) is a British company headquartered in Reading, United Kingdom. The company is active in more than 20 countries, employing over 5,000 people. A significant Liquid Natural Gas business, intended to the sale of natural gas to wholesale customers such as retail gas suppliers and electricity generating companies, is associated to activities of exploration and production of hydrocarbons.

 

The Deal

For every share of BG owned, shareholders will receive 383 pence ($5.71) in cash; and 0.4454 Shell B shares. This amounts to a value of approximately $20.12 per BG share, and hence a premium of approximately 52% premium to the closing price on 7 April 2015 (the day before deal was announced). This gives the deal an implied valuation of $70.18bn. Once the deal is executed BG shareholders will own 19% of the new consolidated company.

 

The Rationale

In the statement released by Shell and BG, several rationales were stated for the deal. The first mentioned was to increase growth in the LNG and deep-water exploration. More specifically, this was done through the acquisition of BG’s new and competitive LNG assets in Australia and deep-water assets in Brazil. As mentioned by Shell’s Chief Executive Officer, Ben van Beurden, “will accelerate Shell’s financial growth strategy, particularly in deep water and liquefied natural gas: two of Shell’s growth priorities and areas where the company is already one of the industry leaders”. Also, these new assets would enhance the rating of Shell’s overall portfolio, and thus reduces capital requirements. This in turn would free up capital to be returned to investors. In fact, Shell expects to commence an aggressive share buyback programme in 2017 of at least $25bn for the period 2017 to 2020. As a final point, the statement claims that the acquisition will result in pre-tax synergies of approximately $2.5bn.

Although these are likely the main reasons for the deal, is indeed useful to closely look also at the general outlook of the Oil & Gas industry. With the oil prices still trading very low, the climate for the industry players has significantly shifted. Although downstream operations such as refining and distribution have seen some upside, those at the higher end of the product chain have experienced important changes. Companies involved in exploration and drilling, or in “tight” oil, that is those who require a higher oil price to break even, have suffered greatly. As a consequence, many of the smaller firms involved in these areas have begun to try to sell themselves rather then face the chance of bankruptcy, despite depressed stock prices. On the flip side, the oil majors’ large cash reserves provides them a good position from which they can begin acquiring both technical expertise and oil and natural gas reserves, in favor of pursuing new sources.

This situation, together with low interest rates and a general positive market environment, sets the basis for another wave of M&A. An example is the American-only $35bn transaction between Halliburton and Baker Hughes of last November already analyzed by our Club.

Indeed, the story between Shell and BG is in part different: although it is true that declining oil prices have inevitably negatively affected BG, the company is still solid giving the greater importance of its LGN business, which is based on a fuel with a fast-growing and increasingly global market and which attracts the interests of a behemoth like Shell. The latter, in fact, struggles not only for the decreasing reserves but also for the increasing competition from national oil companies, such as Rosneft and Sinopec, who are improving efficiency by continuing to integrate vertically and revamp management.

 

The Premium

Declining oil prices play an essential part in explaining the timing of acquisition. The oil drop dragged down the valuations of all energy companies, including BG, which had already been hit by profit warnings and management turmoil. Although this story can provide some context as to why Shell was willing to pay a very high premium in order to acquire BG, a 52% premium to the 90 trading day volume weighted average price of 890.4 pence per BG share on the day before the announcement, is at historically high levels and is maybe excessive. The market reacted accordingly: Shell’s shares fell 5.3% in London, while BG stock ended 27% higher.

Behind this acquisition there are Shell’s expectations of oil rising quickly to $80-$90 a barrel, following an inevitable decrease of the global supply, in primis of the US Shale oil. The issue comes from the fact that there are no guarantees for such an oil rebound and if it will not enough exceed today’s levels, Shell may face serious problems. It is still worth mentioning that while this bet on a sort of mean reversion of oil prices looks risky, the BG acquisition’s also results in a deep exposure to LNG demand growth in Asia, that is increasingly reducing greenhouse gas emissions, switching from oil to natural gas. As a consequence, this might prove an important forward-looking strategic move of Shell, which may even offset the risk of persisting anaemic oil prices.

 

Financial Advisors

Goldman Sachs and Robey Warshaw advised BG, while Bank of America Merrill Lynch advised Shell.
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