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An investment-grade lesson from the Shell-BG supermerger

Screen Shot 2015-04-08 at 08.12.04Article by Bengt Saelensminde published 10 April 2015 by MoneyWeek.com

An investment-grade lesson from the Shell-BG supermerger

This week’s mega-takeover deal between BG and Shell has got the City in somewhat of a tizz.

What a great windfall. The oil and gas sector is on fire right now. Which companies will be snapped up next?

The corporate spiel (as usual in takeover deals) is all about ‘corporate synergies’. Cost savings of £1.7bn each and every year.

But as I’ll show you, this deal has very little to do with any of that.

If you want to put yourself in the right place to profit from these takeover opportunities, then there’s a little trick you need to know.

Something that shows you why companies like Shell shell out big bucks for businesses like BG Group.

The real reason for this megadeal

It’s difficult to over-emphasise the impact the oil price slump has had on everyone in the oil industry.

A mate of mine in the field bemoans his falling salary: “everyone took a 30% hit a last year… and now management is talking about another 20% drop again this year!”

These are serious issues for everyone in the industry. And this blockbuster deal comes at a time when senior management is fearful (though probably not so much for their own salaries).

It’s not pushing it to say there’s a growing panic. Anyone that paints this takeover deal as a confident move by Shell (because they see an imminent rebound in oil) is wrong.

So what exactly is driving this fear and panic? In a word: reserves.

Like most of the oil majors (or super-majors as the real biggies are known), many of Shell’s oil and gas fields are starting to become rather long in the tooth.

Replenishing reserves has been the big idea over recent decades, and that means forking out billions in exploration. Over just the last few years, Shell has somehow managed to explore away £4bn in Alaska alone – and without a single well to show for it!

With the oil price so low, exploration is quickly becoming an unaffordable luxury.

But that produces a significant problem. I mean, these guys weren’t shelling out billions on exploration just for the hell of it. It was to replace reserves.

That’s why Shell is buying BG. It’s not for so called ‘synergies’. It’s not because Shell likes BG’s liquefied natural gas (LNG) technology, nor because they wanted the staff (BG’s head honcho is set to walk away with tens of millions in his pocket).

No, this is all about buying oil & gas assets, reserves, call them what you will.

But how can it be good business for Shell to pay such a monster premium to BG shareholders? How can it be worth 50% more than the day before the deal was announced? Doesn’t everyone use similar valuation models in this game?

Well, no they don’t. In fact, this deal highlights a fundamentally different way of looking at stock valuation.

SOURCE

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