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Deal or No Deal? The Numbers That Matter for Shell’s BG Takeover

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Screen Shot 2015-12-23 at 09.03.45…investors have questioned whether Shell is paying too much after oil prices slumped to the lowest in almost 12 years.

By Rakteem Katakey: JAN 11, 2016

Royal Dutch Shell Plc is a month away from completing its biggest acquisition, which would vault it over Chevron Corp. to become the world’s second-biggest non-state oil company.

The takeover of BG Group Plc would raise Shell’s market value close to $175 billion, boost flagging reserves and production, add to cash flow and bolster its ability to pay dividends, the company says. Yet investors have questioned whether Shell is paying too much after oil prices slumped to the lowest in almost 12 years.

As Shell shareholders prepare to vote on the deal on Jan. 27, these are the charts they should be looking at:

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Shell’s reserves have dropped in three of the last four years, while BG’s have increased in six of the past seven. Oil companies are typically valued on the amount of oil and natural gas they hold under the ground and investors seek out those that consistently replenish reserves with new discoveries. Since 2010 Shell’s reserves have fallen by 563 million barrels while BG has added 796 million.

“Shell with BG is better than Shell alone because of the quality of assets it is buying,” Ahmed Ben Salem, oil and gas analyst at Oddo & Cie in Paris, said by phone. “It sets Shell up for a few years because they will have better reserves to develop instead of spending on expensive exploration.”

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BG’s years of growth in reserves has started to pay off and production has surged since the deal was announced in April. After years of missed targets, Reading, England-based BG was one of the few companies to raise its 2015 output goal as projects in Australia and Brazil started up. Shell’s production dropped in four of the last five quarters.

Slumping oil prices remain the biggest risk to the deal. Brent crude, the international benchmark, has dropped to less than $35 a barrel from about $60 the day before the transaction was announced. Long-term prices have fallen almost as much, with futures for settlement in 2022 around $20 lower.

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As the outlook for the market worsens, Shell has increased its estimate for operating-cost savings from the merger. It plans to cut 2,800 jobs from the combined company and has reduced spending forecasts in an effort to secure shareholders’ backing.

It has failed to convince some. Standard Life Investments, Shell’s 11th-biggest shareholder, said last week that it would vote against the tie-up, citing “downside risks” to the company’s oil-price assumptions among other concerns.

More than two-thirds of the takeover is funded by Shell’s B shares. As oil prices have tumbled, so has the value of the deal, from $70 billion in April to $50 billion as of Monday, according to data compiled by Bloomberg. Shell was offering a 50 percent premium to the market value of BG shares in April. That has now shrunk below 10 percent.

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The oil slump “puts pressure on the deal, it makes it looks like it’s overpaid for the assets,” Brendan Warn, a London-based analyst at Bank of Montreal, said by phone. “But the combination is the right thing for the company long-term. It allows the company to get access to high-margin barrels in Brazil and better access to Australian LNG.”

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Shell, already the biggest non-state producer of liquefied natural gas, will be almost twice the size of its nearest competitor, Exxon Mobil Corp., after the deal. Buying BG would give Shell access to liquefaction terminals from Australia to Trinidad and Tobago, a fleet of tankers to transport the super-chilled fuel and an international team of traders.

Yet Shell will have to cope with an LNG market that’s also going through a slowdown. The price of LNG for short-term deliveries to Northeast Asia, where the biggest importers are located, has sunk more than 26 percent in the past year to about $7.10 per million British thermal units, according to assessments by New York-based World Gas Intelligence.

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The company’s investors care most about dividends. The Hague-based Shell hasn’t cut payouts since the Second World War. It has promised to at least maintain this year’s dividend at the 2015 level, even as earnings plunge with oil prices.

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While Shell says buying BG will enhance its ability to keep the payout safe, the collapse in oil prices has driven its dividend yield to the highest in at least 30 years. Even though Shell has secured backing for the deal from a major shareholder advisory firm, these data suggest investors still don’t fully believe these pledges.


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