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Could Shell-BG Deal Revive Exxon-BP Merger?

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By: MICHEAL KAUFMANPublished: Apr 9, 2015 at 8:05 am EST

Royal Dutch Shell plc (ADR) (NYSE:RDS.A) has announced an agreement to acquire UK-based BG Group plc (ADR) (OTCMKTS:BRGYY) in a massive $70 billion deal. It is one of the biggest merger and acquisition deals in the oil sector for over a decade, and could become the platform for Shell to compete with market leader ExxonMobil Corporation (NYSE:XOM).

Shell will use cash and shares to pay UK natural gas giant’s shareholders around $20.17 (1,350 pence) per share of BG. Compared to BG’s 90-day average stock price before the deal was announced, it implies that Shell has agreed to pay a 52% premium.

The huge premium has surprised investors and analysts alike, especially in the current low-price environment. After averaging at more than $100 per barrel during the first half of 2014, oil price crashed below $50 during the first quarter of 2015.

Shell’s latest announcement to acquire UK-based BG Group at such a high premium gives way to further merger and acquisition activity in the sector and other major oil companies may be looking to strike similar deals of their own. Analysts have anticipated for quite some time that the oil industry would consolidate following a prolonged slump in crude oil price.

The $70 billion acquisition of BG Group will put Shell one step closer to catching up with the largest publicly-listed energy company Exxon Mobil. Shell has a market cap of $202 billion, and could challenge Exxon for the top spot, with the latter’s market cap being $360 billion. As a response, Exxon could look to make its own acquisitions, and UK-based oil giant BP plc (ADR) (NYSE:BP) makes for an attractive target.

Speculation and rumors of an ExxonMobil-BP merger first surfaced last year as BP’s market valuation was hit by the fall in oil price. BP has lost nearly 16% of its market value over the last 12 months as oil price crash has hurt its profitability. As far as valuation is concerned, according to Bloomberg, BP has one of the cheapest market valuations compared to its profit expectations.

The British oil company has dealt with a good part of the environmental and legal repercussions of the 2010 oil spill. However, a multi-billion penalty may be announced by the end of this month, which could worsen the company’s cash struggles. Exxon’s potential takeover of BP would help the British company deal with the financial fallout of such a huge fine. With a market cap three-folds higher than BP, Exxon can better handle the impending fine.

Last month, Exxon CEO Rex Tillerson fuelled rumors of the merger as he hinted that Exxon would be willing to spend big if a deal is attractive enough. Speaking to investors about potential merger and acquisition activity, Mr. Tillerson said: “There is no limitation on what we might be interested in or considering.” He also indicated that Exxon would not hold back from flexing its financial muscle if a “really interesting” deal came up.

With Shell digging deep in its pockets to acquire BG Group, Exxon could be encouraged to go after BP. There are other potential targets as well, with Anadarko Petroleum Corporation (NYSE:APC) and Occidental Petroleum Corporation (NYSE:OXY) being touted by analysts. Occidental has a market cap of $60 billion and Anadarko is currently valued at $44 billion, representing much smaller targets than BP that has a market cap of $123 billion.

Exxon has not explicitly said it would acquire other oil companies but the Shell-BG deal has boosted the probability of merger and acquisition activities by other oil supermajors.

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