08 April 2015

Equity Analyst, Iain Armstrong discusses the merger:

Royal Dutch Shell has confirmed the rumour leaked by the Wall Street Journal last night that it was in advanced talks to acquire BG Group. Today RDS announced that the two boards have agreed a cash and shares offer which values BG Group at £47bn (1367p per share). This is approximately a 51% premium to closing price of BG yesterday.

RDS is offering 0.4454 Shell B shares and 383p in cash. This means that BG shareholders will own about 19% of the combined group. The main highlights are as follows:

  • The deal is expected to be completed in 2016. RDS has forecast at least $2.5bn of pre-tax synergies.
  • The deal will be mildly EPS accretive to earnings in 2017 (based on Brent oil prices of $67 and $75 in 2016 and 2017, respectively) and accretive to cash flow from 2016 onwards.

Those are the numbers what does it mean for the underlying operations? RDS's oil and gas reserves will increase by a quarter, production from the combined group will increase by one fifth. The most striking outcome of the combination(if it happens) is the enhanced position in LNG. The addition of BG will make RDS the largest natural gas producer in the world. RDS bought the LNG operations of Repsol in 2014 and the addition of the superb global logistics and QCLNG will increase that lead over its competitors.

The other good fit is in the deepwater portfolios with RDS getting hold of BG's pre-salt assets in Brazil and increasing the exposure to the North Sea, thereby benefiting from the tax changes.

RDS also benefits from BG's exploration portfolio, particularly in Tanzania. RDS has been unsuccessful in gaining a foothold in East Africa. BG's exploration track record is significantly better than RDS's. BG's reserve replacement ratio has been over 100% for six out of the past seven years in contrast to RDS where the reserve replacement ratio was 26%.

Our initial opinion is quite cautious, given the industry's track record in destroying shareholder value. However, in the long term, the combined group will benefit from being the second largest oil and gas company. The $25bn share buy back from 2017-20 will also help to offset the EPS dilution from the increase in the number of shares but the reduction in return on investment capital in the near term is significant and the boards of both sets of companies will have a huge task on their hands to convince shareholders. Ultimately, we think that they will succeed and there will be one less company for analysts to follow.


-ENDS-

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