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Royal Dutch Shell: Investors Should Reconsider Support of BG Deal

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By Mushhood Khan on Jan 5, 2016 at 9:46 am EST

Just as Royal Dutch Shell plc (ADR) (NYSE:RDS.A) edges closer to its $50 billion takeover of BG Group, investors are losing confidence in the company.

Shell has secured regulatory approval from related authorities across the globe; the deal now only requires the shareholders’ vote, which will be obtained later this month. With oil prices trading at record lows, fund managers who own stakes in both BG and Shell, have reduced their share in the former.

Capital Group, one of the world’s leading investment groups, sold off majority of its stake in the BG deal during December. According to its securities filings, the Group sold around $600 million of BG shares last month, bringing down its stake from 2.2% to 0.9%.

Oil Prices

This loss of confidence, weeks ahead of the shareholder vote, does not bid well for the deal. Offloading of shares in BG implies that the Group does not expect the deal to complete successfully. This is further reinforced by the fact that the investment group has also bought shares in Shell. This move could pay off if the deal falls through, as the company would not need to pay the 52% premium to BG shareholders, and that could increase Shell’s share price.

A significant investor concern, which has created a cloud of uncertainty around the biggest energy M&A deal in decades, is plummeting oil prices. Shell announced the deal in April 2015, when oil prices were trading at approximately $55 per barrel. At that time, the European oil giant assumed $65 per barrel as the average price required to make the deal work. However, since then prices have further fallen to the mid-$30s.

With the shareholders’ vote scheduled on January 27 at Shell and January 28 at BG, oil prices are not likely to swing the momentum in favor of the deal. Some investment banks, including Goldman Sachs, Deutsche Bank, and Citi Group, expect oil prices to fall to $20 per barrel in 2016.

Oil prices would have to recover to $90 per barrel for the average to be $65 – a highly unlikely scenario in the light of recent events.

‘Financial Sense’

Capital Group is not alone in questioning the deal. Head of equities at Standard Life Investments, David Cumming believes that the deal does not make financial sense at current price levels. He told BBC Today’s program last month that it is “very difficult to make the deal work” at sub-$40 levels.

“Shareholders could vote the deal down, and the break fee is pretty low, so I think Shell will come under pressure over the next few months to say how the deal is going to work,” Mr. Cumming told the BBC. Standard Life is a top 20 investor in both companies; while he did not disclose how he would vote, the executive’s statements indicate an increasing likelihood of a failed deal.

Shell has been taking measures to win the shareholders’ backing. The company recently reduced its capital expenditure budget for 2016 by $2 billion, and announced additional job cuts to bring down its costs. Its efforts could be in vain though, as investors are more likely to focus on the substantially reduced oil prices.

Head of governance at Jupiter Asset Management, Ian McVeigh, wrote in the Telegraph that the vote represents “a major opportunity for the largest fund managers to send a powerful message to companies and particularly their advisers.” “This sounds like a classic case of a deal made using other people’s money to me,” he added, while supporting the fund managers’ right to raise concerns over the viability of the deal under low oil prices.

A Contrary View

Analysts and investors have good reason to be concerned about the deal, given the current oil prices. However, Shell CEO Ben van Beurden is sticking to his guns in moving ahead with the deal. He believes the merger would “make Shell a more profitable and resilient company in a world where oil and gas prices could remain lower for some time.”

The deal would unquestionably add valuable assets to Shell’s portfolio, and help it to become the leading player in the global LNG market in the process. $3.5 billion in synergies are expected from the deal; Mr. van Beurden has not dropped a hint of reluctance or second thoughts about the acquisition.

As he remains undeterred, the arbitrage discount has narrowed in recent weeks. Last week, BG shares were trading at a 14% discount to Shell’s bid price, which reflects an arbitrage opportunity for investors who expect the deal to go through. The discount narrowed to 9% at the close of markets, on Monday. The contracting arbitrage discount reflects increased expectation of a successful deal.


We believe that while Shell continues to move ahead with the deal, it would be a wise move on its shareholders’ behalf to consider the implications of the deal in the current pricing environment, before voting in its favor.


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