Even More Global: Shell Megamerger Offers Big Premium For BG Group

In a game changer for global LNG, Royal Dutch Shell Plc. (NYSE: RDS.A) has offered to buy BG Group for about $70 billion, mostly in stock.

Shell agreed to pay a premium of about 50% to BG Group’s April 7 closing price, with 28% in cash (roughly $19.6 billion) and 72% in stock. In unadjusted dollars, the last deal of such magnitude was the $75 billion ConocoPhillips (NYSE: COP) merger in 2002.

Shell’s purchase gives it industry-leading positions in deepwater oil offshore Brazil and LNG.

Tudor, Pickering, Holt & Co. said the deal makes strategic long-term sense and that Shell’s high payout is in-line with BG’s net asset value at $95 per barrel (bbl) Brent. The market’s negative reaction was a response to Shell’s near-term dilution of stock. Shell shares were down 2.5% in London trading, while BG Group shares were up 44%.

“Shell gains access to arguably the best deepwater oil resource globally—Brazil presalt—and becomes the undisputed global leader in LNG, where scale matters,” Tudor said. “It is a conscious decision to de-emphasize U.S. shale and to stick to its strengths, deepwater/LNG.”

The deal sets Shell apart from the other supermajors by ensuring long-term growth in upstream production but also in terms of LNG volumes. It gives Shell higher oil price gearing and makes it more of a bet on higher oil prices and LNG prices, Tudor said.

Wood Mackenzie broke the deal down into three components: deepwater oil, LNG and hidden value.

Primarily, “it’s about deepwater oil,” the research firm said. A real prize for Shell is the oil in deepwater Brazil. BG estimates its offshore potential at 3.5 billion barrels of oil equivalent (boe).

In 2015, 60% of BG’s production is gas but the proportion will decline over the next 10 years to 50% as the giant Brazil presalt fields come onstream. By 2025, Brazil will be delivering 550,000 bbl/d—13% of BG/Shell’s total production and the biggest single country position in the combined portfolio.

The Shell-BG combination has the potential to increase Shell’s Brazil production from 52,000 boe/d in 2014 to an estimated 550 Mboe/d by the end of the decade, said Guy Baber, analyst, Simmons & Co. International.

“In addition to the LNG portfolio, the crown jewel of the deal is the Brazilian presalt assets,” Baber said.

Wood Mackenzie said the acquisition will create a LNG behemoth with unmatched scale and flexibility. The deal combines the two largest international oil company LNG players to create an industry giant.

By 2018, the combined entity will control sales of 44 million metric tonnes per annum (MMtpa) of LNG, making it the largest LNG seller in the world. Shell will have unrivalled flexibility and exposure to virtually every major LNG supply source and market globally, which means significant scope for portfolio optimization. Shell’s deal kick starts its LNG development pipeline, adding a leading U.S. position, entry to East Africa and new options to expand an already giant presence in Australia and Canada.

With Shell planning $30 billion in divestitures from 2016 to 2018, value should be created when the oil markets recover and the company begins to exit positions or assets that no longer fit.

“This is an important transaction for Shell,” said Jorma Ollila, Shell’s chairman. “It’s a bold and compelling move, and one that the Shell board has considered very carefully over a substantial period of time. We firmly believe that this is the right strategic next step for Shell’s shareholders, and for the shareholders of BG.”

Andrew Gould, BG Group chairman, said his company brings a strong group of assets focused on gas and oil exploration and production and on LNG.

“This is an important transaction for Shell,” said Jorma Ollila, Shell’s chairman. “It’s a bold and compelling move, and one that the Shell board has considered very carefully over a substantial period of time. We firmly believe that this is the right strategic next step for Shell’s shareholders, and for the shareholders of BG.”

Andrew Gould, BG Group chairman, said his company brings a strong group of assets focused on gas and oil exploration and production and on LNG.

BG has sourced LNG from 15 producing countries and is expected to add the U.S. as a supply source with contracted volumes from the Sabine Pass LNG terminal in early 2016.

“As the market expands, we are assessing further supply options, including Lake Charles, La., in the U.S., Tanzania and Canada,” Gould said.

Tudor noted that the deal is dilutive to near term price-to-earnings ratio and is negatively impacted by $2 billion of incremental depreciation. Shell sees the deal as accretive to cash flow from operations per share in 2016 at $70 Brent.

Christian Stadler, a strategic management professor at Warwick Business School in the U.K.,said Shell missed out on the late 1990s megamerger wave due to their complex shareholding structure.

The company was the product of an unconsumed merger, with 60% Dutch and 40% British. Mobil would have been a perfect fit for the company but ended up in the arms of ExxonMobil Corp. (NYSE: XOM) because of the split.

“This time round Shell has no such issue, being a normal U.K. plc,” said Stadler, who has studied and worked with Shell for the past 15 years.

Shell’s deal echoes the late 1990s mergers when oil plummeted and cost pressure set up obvious paths to growth.

For Shell, the acquisition could replace reserves after its failed attempts to join the U.S. shale boom.

“BG would fit well with Shell’s portfolio. Shell has a very good track record in offshore oil and gas fields, and BG will help them solidify this area,” Sadler said.

The oil fields Shell want to acquire will also help to shore up inventory the company has lined up to replace its production.

“On the downside, never underestimate the issues associated with megamergers,” Stadler said. “Shell’s decentralized approach is an advantage here but also reduces cost-cutting potential. Shell gives lots of freedom to its different entities, usually country operations, so it could give BG substantial freedom.”

Cost savings can be much harder to achieve, though with the current downsizing in the oil industry some job loss should be expected, he said. Shell has 92,000 employees in 70 countries.

However, if the company’s objective is top line growth, its decentralized model is a better way to go, said Dennis Cassidy, head of the oil and gas practice at AlixPartners, a global business advisory firm.

The deal fits strategically with Shell’s vision of an emerging global gas market.

“Shell is very bullish on natural gas,” Cassidy told Hart.

The merger will require approval in many countries, such as the U.S., Brazil, Australia and elsewhere, Cassidy said. Shareholders will also have to give a nod to the deal.

“In terms of the approval process, or potential divestitures, there still have to be some due to Shell’s presence in certain markets and infrastructure,” he said.

The good news for Shell is that its upstream assets and raw natural gas are part of a fragmented market. That will make it difficult for anyone to object to Shell having undue influence on prices.