BG Group
Cost of Shell share buyback $25bn
Depending on which way you look at it, both BG Group and Royal Dutch Shell have got the worst of their proposed merger. Both sets of investors might comfort themselves, then, that it has been pitched about right.
From BG’s perspective, there is no question that they are being asked to sell at the bottom of the market. They will end up with 19 per cent of the merged group, but in return for contributing assets are, by some arguments, rather better than on the other side.
The amount they are getting back is somewhere short, as the Shell price stands, of the BG share price at the start of last year, before things began to go badly awry, and well before the oil price began to tank last autumn. BG’s record on exploration is, by one measure, significantly better than Shell’s. Its replacement ratio over six of the past seven years — that is, the amount of fresh reserves found each year as a proportion of those coming out of the ground — has run at above 100 per cent. Shell’s latest figure was 26 per cent.
This explains why it wants access to those assets, which are also rather less costly to extract than Shell’s in places such as the Arctic and the Gulf of Mexico.
On the other hand, BG investors are seeing a more comfortable end than any might have hoped to one of the most uncomfortable periods in the company’s history, with the chance to participate in any upside for the merged company. The deal is not necessarily a done one, although it is hard to see any other bidder coming in; there are plenty of questions over that potential upside.
This probably explains the odd behaviour of BG’s shares in the market yesterday, rising to close to the terms on offer and then collapsing. At their £11.53 close, they stand at about 130p below the terms on offer from Shell. I suspect plenty of traders will have taken a look at that early share price and decided to cash in and take that gain.
BG investors thinking of sitting it out until completion early next year should be aware of the potential downside. First, such mega-deals are horribly hard to pull off, while the regulatory risk is there — the list of authorities that have a right to get involved runs for pages in the formal announcement of the agreed deal.
There is concern over Shell’s level of debt — it has to pay out £13 billion in cash to buy BG and find another $25 billion or more for a share buyback to support its price, with the assumption that these costs can be defrayed by the promised $30 billion sale of assets against a background of a low oil price that will depress what it can get for these. Then there is the cost of the promise to maintain the dividend this year and next — Shell has not cut since the Second World War, allowing for moves in exchange rates.
The company reckons to be comfortable with gearing of up to 30 per cent. One analyst suggests that the BG purchase could push it to approaching 40 per cent, although this makes various assumptions on those asset sales.
The actual metrics of the deal are eye-watering. This year is the nadir of BG’s fortunes, but the earnings multiple for 2016 is something like 31 times. On the other hand, Shell is paying a discount to BG’s assumed net asset value per share. It is, however, also making some punchy assumptions about the future direction of the oil price. The company insists that the merger makes sense at any level, but the fact is that it is paying an amount of cash for assets whose value will rise and fall dependent on that price.
For BG investors, my advice would be to hang in there. You are promised a flow of dividends until the deal completes, even if the company is not the most generous payer on the market.
Should the price start to rise to approach the deal terms, and bearing in mind it is a year or so until you get your money and Shell shares, I would be tempted to take profits in the market and thank your lucky stars that M&A has at last come back to the oil and gas sector — as, to be fair, I have been saying for a while that it would.
Gamblers might consider picking up BG shares if they stay this low and seeking to benefit as that gap closes. As to Shell, the 6 per cent dividend yield is attractive, but I would not be buying now.
My advice Hold
Why The gap between the terms on offer and the BG price is wide; investors should wait for it to narrow and then consider taking profits
All joking aside, Sid has had the last laugh
“Tell Sid he already owns it” was the cynical joke that went around in 1986, when the government used the mythical investor Sid in its advertising campaign to encourage the public to buy shares in British Gas.
Actually, the Sids did rather well out of what was one of the biggest privatisations of the Thatcher era. In all, 1.5 million people signed up. The minimum purchase, of 100 shares, cost £135.
The subsequent history of British Gas was complicated. In 1997 the company was demerged into two, shareholders getting one share in Centrica, which got the old British Gas business and name to which we pay our gas bills, and one in BG Group. There were various changes to BG’s capital structure and BG’s Transco gas distribution network was hived off and went to National Grid.
Research by Hargreaves Lansdown, the financial specialist, suggests that that initial investment of £135 is now worth £1,652.06, broken down into holdings in three companies, if none of the shares had been sold.
Sids have made their money back more than twelvefold — and that does not take into account all dividends paid to each of the individual entities since. Those holders of that initial 100 shares have 93 in BG, worth £1,160, 89 in Centrica, worth £233, and 29 in National Grid, worth £259.
Follow me on Twitter for updates @MartinWaller10
