That Shell (LSE: RDSB) (NYSE: RDS-B.US) might bid for BG Group (LSE: BG) was one of those much-talked-about-but-never-likely-to-happen mega-deals. Well, it's happening, and here's why it's good news for both sets of shareholders:
Shell's great timing
1. It boosts Shell's reserves cheaply.
Shell will increase its reserves by 25% and production by 20%. Exploring for oil and gas is expensive and risky. Buying someone else's reserves is cheaper and easier - especially when oil prices are depressed and the target has encountered set-backs, as BG did;
2. It gets prime position in LNG.
Both Shell and BG have invested heavily in integrated liquefied natural gas (LNG) businesses - getting the gas out of the ground, liquefying it and shipping it. The economics of LNG are different from oil, with cargoes easily transported to the highest bidder -and Shell will become the dominant player with a 16% global market share;
3. It gets a bigger foothold in Brazil.
BG made big discoveries in Brazil's off-shore pre-salt basin, but proved better at exploration than exploitation. Those reserves are complementary to Shell's own Libra off-shore Brazil assets and its deep water expertise;
There's no doubt scale works in the oil industry so the mooted cost savings should be deliverable, if not exceeded. With a dual focus on deep-water and LNG, there will be plenty of scope to dispose of non-core assets;
5. A strong balance sheet means the prospect of share buy-backs.
Shell's low gearing means that pro-forma gearing of the combined group after the transaction is only 20%. Debt reduction will be a priority but if oil prices rise as Shell expects then it plans share buy-backs from 2017.
BG Group's swift upside
1. A 50% share-price premium.
With BG's share price hammered by management mishap, emerging market politics and the oil price plunge, it would have taken a long time for new CEO Helge Lund to turn around the company's fortunes. A 50% premium to the past three-month average provides swift recompense for BG shareholders;
2. Shell shares at good price.
Shell's own shares have been weak in the face of the depressed oil price. BG shareholders will likely look back and think this was a great time to become a Shell shareholder;
3. It dilutes BG's Egyptian problem.
With major Egyptian natural gas assets, BG became an unwitting victim of instability in the aftermath of the Arab Spring. Export production was cut off and receivables due from the State rocketed up to $1bn. A deal last month with the new Egyptian government looks promising, but nevertheless what was a major headache for BG becomes a minor irritant in the enlarged group;
4. It eases BG's management challenges.
BG shareholders seemed confident that expensive star-signing Mr Lund would turn around the company's fortunes, but management turmoil and tight finances would have made the job more difficult. Instead the challenge will be integrating the two businesses;
5. Shell juicy dividends.
Finally, BG shareholders will get Shell's juicy dividends. Shell has confirmed it will at least maintain the payout for the next two years, which on today's share price equates to a massive 6.5% yield.
BG shareholders lose the potential upside from the company's fantastic record of discoveries, but they get a more certain cash flow in return. Shell's shareholders get great assets at a great price. In the current circumstances, it's a win-win.
Mega-takeovers come along just occasionally, but there can be big gains when they do - and the oil sector may just be seeing the start of an M&A frenzy. If you're eager to make money from the stock-market, but are wary of get-rich-quick tipsters, then I recommend you read 'Ten steps to making a Million in the Market'. It's an exclusive publication from the Motley Fool, with sound and sober advice about how to become an ISA millionaire. It's free and without obligation -- just click here to read it.
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