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BG GROUP

Royal Dutch Shell/ BG – merger will create largest co in UK 100

During a Bloomberg conference call yesterday morning, Royal Dutch Shell CEO Ben van Beurden said BG made a compelling merger fit and that the timing of the acquisition (in the context of the oil price collapse) was the best in years. A merger between Shell and BG had been discussed “on and off” for a decade.

 

BG adds 25% to Shell’s “proved” P1 oil reserves and 20% to oil & gas production whilst adding its LNG (liquefied natural gas) portfolio (c. 16% of global LNG) and its offshore assets in Brazil, Tanzania and Australia. The asset side combination diversifies Shell considerably adding growth assets principally in Brazil to offset declining production from Shell’s West African oil fields in Nigeria and Gabon.

 

On the synergy side, in terms of capital expenditure adding the two budgets together gets to $42bn (BG spent $9.7bn in 2014). Shell expects to reduce capital spending by $2.5bn post-merger though it could reduce spending by c $4bn. The merger would mildly boost EPS in 2017 but strongly boost EPS in 2018 assuming Shell’s forecast assumption of $75 oil in 2017 and $90 in 2018-2020.

 

Shell does not expect a change in its debt ratings (S&P AA, Moody Aa1) as its balance sheet gearing would have been c.20% using end 2014 numbers on a pro-forma basis (ie. if both companies had been merged end 2014). It is worth noting though that both rating agencies have negative outlooks given the oil price context.

 

The BG merger terms break down as follows; 9.52p interim dividend (ex 23rd April 2015) plus 383p (cash per share) plus 0.4454 RDS (B) shares per BG share. This equates to a grossed up value of 1700.6p per RDS (B). Not only is this a 12.3% discount to Royal Dutch Shell B shares (2002p- 62p expected RD dividend) it offers a forward yield of 7.47% based on Shell’s promised $1.88 (127p) 2016 dividend.

 

Recent FY14 results from BG Group, loss of $5.03bn after $8.9bn of asset write downs were uninspiring. Crucially BG’s production growth that, during 2010-2013 had caused BG’s shares to trade at a premium to the oil sector, had ended. During Q4 2014 BG’s E&P production was 630k boepd (barrels of oil / oil equivalent per day) down 1%, over 2014 production was down 4%. BG has the quandry of further commitment to Egypt after losing $2bn in 2013 and a further $750m during 2014 in Egypt. Shell has rescued BG from problematic capital commitments in 2015.

 

BG takeover premium of 50% is a massive premium. £47bn ($69.5bn) represents $40.4bn above (2.4x) BG’s end 2014 book value of $29.1bn. There are a number of oil companies at discounts or near to book value, (BP) that are cheaper. Has Shell overpaid? That was the kneejerk response in Shell yesterday and that looks clear.

CONCLUSION

“Deal risk” is attractively priced, at 1150p- BG is a cheap way into Royal Dutch Shell at 1700p with an attractive near 7.5% forward dividend yield. We see deal completion as at least six months away ie Q4 2015 assuming no delays/ deal failure.

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