Zero Hedge
0
All posts from Zero Hedge
Zero Hedge in Zero Hedge,

The Shell-BG Megadeal: All You Need To Know, And Why The Initial Response Is Not Enthusiastic

As previously reported, overnight oil giant Royal Dutch Shell agreed to buy BG Group for £47 billion ($69.6 billion) in cash and shares, the 14th largest ever corporate takeover, the largest energy transaction in the past decade, and as the WSJ put it, "the latest sign of how tumbling energy prices are shaking up the global oil-and-gas industry."

The catalyst for the rushed, and unsolicited, deal: the sharp drop in oil and gas prices since last summer, with the hope being that thousands of layoffs and operations synergies would enable the two European energy giants to eliminate overlapping costs to lower the breakeven oil production cost.

As the WSJ, which broke news of the deal first, adds, the combination "furthers Buying BG will add 25% to Shell’s proved oil and gas reserves and 20% to production and give it access to BG’s highly prized offshore oil fields in Brazil’s Santos Basin, significant undeveloped natural gas resources in East Africa and a huge liquefied natural gas project in Australian that is ramping up this year."

Here are the key deal terms and conditions:

  • 0.4454 Shell B shares and 383p in cash per BG share
    • Represents a value per BG ordinary share of 1350p, a premium of 52%
    • Values BG equity at £47.0 billion3
    • BG shareholders to own 19% of Shell
  • Equity increase:
    • 1,532 million new B shares
    • Election option for A shares
  • ‘Mix and match’ election between cash and shares
  • Purchase price allocation (IFRS 3 + 13)
    • ~ - $2 billion post-tax P&L annual impact
  • To be implemented by Scheme of Arrangement
  • Key conditions: shareholder + regulatory approvals

Here is Shell's pitch to its shareholders why they should endorse the deal:

  • Mildly accretive to earnings per share in 2017 and strongly accretive from 2018
  • Accretive to cash flow from operations per share from 2016
  • Accelerates deep water + LNG strategy
  • Accretive to earnings and cash flow per share
  • Complementary portfolios: synergy opportunity
  • Enhanced portfolio: springboard to high-grade Shell + BG
  • Improved cash flow enhances future dividends + buyback potential

Some, see below, disagree with the proposed corporate assessment.

The combination as summarized by Shell:

  • Enhanced position in our growth priorities: LNG + deep water
  • Complementary fit in 15 countries
  • ~$2.5 billion/year synergies* identified + further potential

Why pay a massive premium for BG Group? Here is the politically correct slide explainer:

 

The full investor slidedeck is presented below:

 

 

To be sure, while BG Group soared 37% following the announcement, Shell stock is less than enthused and was down 2% at last check.

Why? The following initial response note from BMO may provide some color on why deals of desperation are never good for investors or management.

BG Group and Shell have announced this morning following a leak in the Wall Street Journal last night that BG has agreed to be acquired by Royal Dutch Shell in a cash and shares transaction. If this deal is completed this would be the end game of a pursuit that began shortly after the listing of the original British Gas group in the 1980s. Shell is paying a very large premium of c 50% to the current 30 share price of 910.4p, which would value BG at US$70bn, which would be one of the largest oillgas deals in recent history. The deal will add 29% to Shell's reserves, 20% to its current production and 27% to its LNG liquefaction volumes. Shell is saying that it has identified US$2.5bn of annual synergies from 2018. Shell is also expecting the deal to be mildly accretive to EPS but strongly accretive to cashflow in 2016. There will by two conference calls at 9am and 2pm London time today.

 

Our View:

  • We think the prime attraction of BG for Shell is its LNG position, which makes up 39% of our current asset value of the company of 1,027p. Combining the two companies would result in LNG liquefaction volumes of 33mtpa, based on 2014 numbers, well ahead of Exxon, the No. 2 player. There is significant growth coining from BG, which is about to start up its QCLNG project, which would add a net 6 mtpa., plus the potential of Tanzania. Shell is forecasting pro-fornia liquefaction combined volumes of 45 mtpa in 2018.
  • BG will also bring a solid position in the Brazilian pre-salt, which should amount to net production of 486 kboe/d in 2020 and is 45% of our asset value. The wrinkle in this is that Shell would be the non-operating partner of Petrobras, which is currently in turmoil due to the widespread corruption allegations. It would add, however, to Shell's existing Brazil position, which includes a 20% share of the giant Libra project.
  • Other operational benefits include BG's North Sea assets, its position in Karachaganak in Kazakstan, and less important assets in India, Thailand, North Sea, Egypt.
  • From our valuation perspective for RDS the BG deal is significantly dilutive, both from a multiple and asset value perspective. Shell is paying a P/E of 66.6x for BG at the acquisition price, although RDSA was trading at only a 12.1x 2016 multiple pre-deal. On an EIT/DACF basis, Shell's 2016 multiple is 6.2x, whilst it will be paying 11.7x for BG. RDS would also be paying a premium of 26% of BG's asset value, we estimate, even after the synergies are accounted for. We estimate that our PDS NAV is diluted by 8% as a result of this the deal. For these reasons we think the market will be sceptical about this deal and we believe Shell will have to work very hard to convince shareholders that the strategic benefits outweigh the premium offered.

All valid points, especially the bolded, however as long as starved for yield bond investors are willing to throw money away, more deals like this one will take place. Ironically, mega mergers like these which cut overhead and boost productivity and efficiency (at the cost of tens of thousands of workers) mean the oil glut will persist for much longer than even the most pessimistic estimates.