Helal Miah, our investment research analyst, delves into BG Group and explains what Royal Dutch Shell’s takeover proposal could mean for its investors
Big Oil: What can BG Group investors expect from Royal Dutch Shell’s proposed takeover?
26 April 2017 update
With hindsight, the timing of Royal Dutch Shell’s acquisition of BG Group couldn’t have come at a worse time. Back in early 2015, when the deal was announced, oil and energy prices were already on the way down, but not many foresaw the prospect of oil prices heading all the way down to roughly $27 a barrel in early 2016. Nonetheless, Royal Dutch Shell continued with the acquisition believing in the longer term benefits of the deal.
However, looking at the latest set of full year results (2016), it would seem quite apparent that Royal Dutch Shell did overpay for BG group reflected by the impairment of assets. There were also significant integration related costs which hampered profitability.
The $50 billion takeover also left Royal Dutch Shell with and eye watering net debt load which last stood at roughly $73 billion, about three times the level before the takeover. To pay down this debt in a low oil price environment the oil giant has been selling a number of assets around the world, including disposals in the North Sea, Nigeria and Saudi Arabia. $15 billion of the planned $30 billion of asset disposals have already been completed during 2016 with a large portion of the remaining already agreed or making good progress.
Now that the integration of BG is largely completed, it leaves Royal Dutch as a much bigger entity with a roughly 50% increase in gas production and an important player in the global liquefied natural gas market. Gas now accounts for about half of the combined group’s production, BG’s assets in Brazil also gives Royal Dutch Shell access to deep-water operations and helps lift oil & gas reserves and production volumes. The cost synergies have been greater than initially anticipated, the combined entity runs at an underlying operating cost that is $10 billion lower than two years ago.
Meanwhile, natural gas is increasingly being used as a cleaner substitute to coal in electricity generation in the developed nations.
So while the timing of the BG acquisition is questionable, it makes strategic sense when looking at the longer term expected developments in the global energy market. Investors will naturally be aware that the key factor to returns will be the price of oil and gas, which many analysts will find hard to predict correctly. However, Royal Dutch Shell, like many other mega-cap energy producers has been on a major cost cutting and streamlining exercise since the collapse in energy prices. These companies are now far better positioned to enable them to navigate their way through a low oil price environment, any sudden rises in energy prices could therefore now be seen as a bit of a bonus. Meanwhile the Royal Dutch Shell management are very keen on rewarding investors through a very attractive dividend.
BG has had a difficult few years, having to contend with operational issues along with political turmoil in Egypt. On top of this, like most other energy companies, it is now facing a low oil price environment which has further knocked its share price.
Despite various operational difficulties, BG has long been talked about as a takeover target by a larger rival due to the prospects of its key Brazilian and Australian assets. In April, BG confirmed and recommended a takeover approach from Royal Dutch Shell. For each BG share, investors will receive 383p in cash and 0.4454 Royal Dutch Shell B shares and this is roughly a 50% premium on where BG were trading before the announcement. The deal is not expected to complete until the 1st half of 2016.
The shares will now closely track the movements in Royal Dutch Shell. A key risk to BG’s share price is now the prospect of the deal falling through as a number of regulators in various parts of the world will have to approve the merger. However, this is unlikely and some regulators have already approved the merger. A regulator is more likely to demand some parts of BG and Royal Dutch to be disposed of so that the combined group does not have too dominant a market share in some markets before approving the acquisition rather than rejecting the merger outright.
BG shareholders will end up holding about 19% of Royal Dutch Shell. They will be shareholders of a much bigger energy group with a wider portfolio of assets, energy products and geopolitical exposures. In some ways BG shareholders should welcome this because we consider the larger group to be less risky and will pay a far better dividend yield. Royal Dutch Shell B shares in its current form pays just above 6% while BG group pays just under 2%.
However, shareholders in BG will have invested because of its growth prospects from the vast resources it discovered and is developing in Brazil and Australia. The new combined entity will be a little more lacking in potential capital appreciation amongst investors eyes. Therefore medium/high risk growth focussed investors may want to look elsewhere.
BG investors should have been pleased with the big jump in the share prices at the time of the announcement but some in the market suggest that Royal Dutch have paid too much, especially given the supply glut in the world energy markets at the moment. However, when considering the potential cost synergies, where estimates have ranged from $1-£2.5Bn a year, it makes some sense. BG is more gas focussed while Royal Dutch generates as much from gas as it does from oil. The two have significant LNG operations in Australia, most of which is exported to nearby Asian markets.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.