On April 8, Royal Dutch Shell (RDSB) announced its intention to acquire BG Group (BG.) in a cash-and-stock deal that values BG’s equity at £13.50 per share, or 11% above our current £12 fair value estimate. The deal will be roughly 70% stock and 30% cash, and is expected to close in early 2016.
Our BG thesis has been that near-term execution problems and political issues in Brazil and Egypt were creating an attractive entry point for long-term investors. And to be sure, a company of Shell’s size and financial health is in a great position to take a long-term view. But the 50% premium Shell is offering over BG's April 7 closing price is nonetheless a rich offer.
We plan to adjust our valuations to reflect the risk of this acquisition not going through, but nonetheless will be increasing our BG fair value estimate and lowering Shell’s to reflect the offer price, although our moat ratings for both companies are unchanged.
From a regulatory standpoint, there is some risk that a deal of this size could run into hurdles, as evidenced by BG’s shares currently trading roughly 14% below the implied price of Shell’s offer. As discussed by management, regulatory and/or antitrust approvals are needed from the EU, Brazil, China, and Australia. We expect to risk the value of this deal for each company by about 10% to reflect the chance that it is not consummated as planned.
Shell intends to significantly restructure the combined company by selling $30 billion of assets during 2016-18 and cutting capital spending compared with what each company was planning to spend on its own. Approximately $1 billion in operating synergies are also expected to be realized by combining the companies. Provided that oil prices recover and reach at least $70 per barrel in coming years, management believes it will be in a position to repurchase $25 billion of shares during 2017-20. Combined with the company’s pro forma $14 billion annual dividend, this is a significant return of capital to shareholders.
At first glance, we’re sceptical Shell can actually fund its capital budget and such dividend and buybacks levels even at our long-term forecast of $75 Brent. There’s clearly a risk that this turns into yet another instance of an oil major over-promising and under-delivering on its future targets provided to investors.
Once finalised, Shell will see its proved reserves and current production increase by 25% and 20%, respectively. Of BG’s assets, the crown jewel is its Brazilian oil resources in the Santos Basin. We estimate BG’s Brazilian projects can breakeven at roughly $35-$40 per barrel, making it some of the lowest cost oil in the world.
That said, Petrobras is the operator of the Santos Basin, which certainly increases the risk given the bevy of issues that firm faces. Even so, these projects remain one of Petrobras’ highest priorities and are already far along the development path; we expect production to be online and producing within a few years’ time. BG’s Brazilian interests include more than three billion barrels of recoverable oil resources.
