Royal Dutch Shell acquisition

Royal Dutch Shell a global group of energy and petrochemical companies. I have a holding in my income portfolio (epic code: RDSB)

Royal Dutch Shell announced today a recommended cash and share offer for BG.  The details of the deal are for each BG share 383p in cash and 0.4454 Shell B Shares. 

 

This deal equates to a value of ~1350p per BG Share; a premium of approximately 52% to the 90 trading day volume weighted average price of 890.4p per BG Share on 7 April 2015.  The total value of the equity is $69bn and ~$12bn of debt will be assumed, so the enterprise value (EV) of the deal is $81bn, compared to Shell's $232bn  

 

Shell state that the Combination will add some 25% to Shell's proved oil and gas reserves and 20% to production, on a 2014 basis.  Shell also expects the Combination to generate pre-tax synergies of approximately $2.5bn per annum.  Management expects the Combination to be mildly accretive to EPS in 2017 and strongly accretive to EPS from 2018 onwards

This is a very high priced deal at 25x expected 2016 earnings and even after allowing for the expected synergy savings, which might be say $2bn post tax ($2.5bn pre-tax), the price is 15x earnings, compared to Shell's 11x earnings rating.  The price which is 35% of Shell's EV gives them only a 25% increase in proven oil and gas reserves.

On an EV to estimated free cash flow (FCF) basis it looks to be accretive further out, but this relies on crystallising those savings and a factor outside of the control of both companies a higher oil & gas price:

Shell have confirmed that they will maintain the dividend this year at $1.88 and expect to introduce a $25bn share buy-back programme from 2017 to 2024, which would go some way to off-setting the dilutive1.5bn of shares that will be issued in this deal.  At prices up to 2300p, a buy-back would make economic sense, but I am not convinced they are that disciplined.

Of all the major oil & gas companies, Shell has the greatest interest in gas and this acquisition will enhance that gap.  This deal may be a major play on the future of natural gas and the larger role it has to play in world economies over the long-term and for that it may make sense 5-10 years from now, but for the medium term - not a great deal except for holders of BG shares.  The price was down over 5.7% this morning at 2080p.