Shell can make BG deal work (or so it says)

November 3, 2015 03:03 PM

Royal Dutch Shell sought to ease investor concerns over its planned $70 billion takeover of BG Group on Tuesday, announcing further benefits and cost cuts aimed at making the deal work with an oil price in the mid-$60s a barrel.

The Anglo-Dutch group, which hopes to complete the deal early next year, said it now expected savings to increase by $1 billion to $3.5 billion for the combination which will make Shell a leader in liquefied natural gas (LNG) and offshore oil production in Brazil.

Shell, which last week reported a huge third-quarter loss due to $8 billion of write-offs in Alaska and Canada, said it would cut costs by $11 billion in 2015 to cope with a prolonged period of lower oil prices, currently trading below $50 per barrel.

"Although oil prices have fallen in 2015 the valuation case for the BG acquisition still looks compelling today for both sets of shareholders," Shell Chief Executive Ben van Beurden told reporters.

Investors have been concerned that the deal would be at risk as a recovery in oil prices is now expected to take much longer than predicted in April, when the BG transaction was announced.

Back then, Shell indicated it expected oil prices to recover to $90 a barrel by 2020.

Brent crude was around $59 per barrel when the deal was announced and has since traded between about $42 and $69 amid a growing consensus among analysts that prices are set to stay "lower for longer."

"The benefits (of the acquisition) come from delivery of growth projects which will deliver cash flows not over 6 months or 12 months, but over 15-20 years, that's the real value," Shell Chief Financial Officer Simon Henry told investors.

To make the integration of BG's large gas-focused business, and especially its prized liquefied natural gas unit, easier, Shell said it would create a new upstream organization called Integrated Gas.

Maarten Wetselaar, Shell's Singapore-based head of integrated gas, will lead this business, which alone generated $11 billion of cash flow over the past three years, from the Netherlands starting Jan. 1, Shell said.

Valuation gap

BG shares trade at a discount of more than 10% to the valuation of the cash and shares deal, reflecting investor concerns over its viability and remaining regulatory hurdles. Shell needs the approval of Australian and Chinese regulators before the deal can be put before shareholders.

Shell shares were up 1.4% by 1022 ET, trailing a 1.7% rise in the European oil and gas sector. BG shares were up 1.6%.

"No real new surprises today. We expect more in terms of pre-tax synergies once the two groups combine," Brendan Warn, Managing Director of International oil & gas equity research at BMO Capital Markets, said.

"Shell's commitment to operate at a lower oil environment and maintain share buyback may reduce some investors' concerns."

BMO rates Shell as "underperform."

Shell reiterated plans to sell $50 billion worth of assets between 2014 and 2018 partly to cover the cost of the acquisition.

It said it would maintain its dividend payout in 2015 and 2016 at $1.88 per share, turn off scrip dividends in 2017 and undertake a share buyback of at least $25 billion in 2017-2020.

The $3.5 billion savings were expected to comprise of $2 billion from operating costs, mainly in the corporate and IT units and another $1.5 billion in exploration spending in 2018. The savings will result in a one-off charge of $1.23 billion.

"The BG deal will make will Shell a far better company beyond 2017, but until then a lot of divestments and levers need to be pulled to cover dividend," Warn said.

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