Royal Dutch Shell plc (ADR): Were Investors Right in Supporting the …
Royal Dutch Shell plc (ADR) (NYSE:RDS.A) investors voted in favor of the multi-billion dollar transaction to acquire BG Group this Wednesday, marking the biggest deal to be approved in the energy space for at least a decade. The European oil giant has won approval from regulators across the globe for the proposed merger, and investors yesterday voted 83-17 in favor of the acquisition. However, falling oil price has made matters complicated for Shell in completing the deal. The $50 billion deal, first announced in April last year, has come under scrutiny in recent months as crude oil price touched record lows. When Shell agreed to pay a 52% premium to BG Group plc (ADR) (OTCMKTS:BRGYY) shareholders last year, oil stood around $55 per barrel. A recovery was largely expected by the start of 2016, but price fell even deeper. Currently, one-month forward Brent crude oil futures are trading at $32.80 per barrel, while West Texas Intermediate crude futures are trading at $32.00 per barrel.
The graph shows the 50% drop in the United States Oil Fund LP (ETF) (NYSEARCA:USO), a fund that tracks the movement of oil, against the 32% drop in Shell shares. BG shares managed to gain 7% during the same time period. The main concern for investors is the sharp fall in oil price since the initial announcement of the deal. Shell claims it can still generate synergies of $2 billion a year from a successful integration of the two companies, but surely, halving the price of its largest revenue contributor has to take a toll on the economics of the deal at some level.
Supporting the Deal
Large investor groups have been supportive of the deal, with the most common argument being that the benefits of the Shell-BG merger would be realized over decades. They contend that these payoffs cannot be judged using the current spot price of oil. The current level of oil prices is seen as temporary, and a rebalancing of demand and supply in global oil markets is largely expected to start during the second half of 2016. Earlier this month, CEO of Shell Ben van Beurden expressed his belief that oil is going to settle higher. The oil prices we are seeing today are not sustainable and are going to settle at higher levels, Mr. van Beurden told the Sunday Times. And higher, in my mind, over the next few decades that the low $60s that we require to make this deal a good deal, he added. A few weeks back, Shell said the deal can still work with oil at around $50 per barrel the lowest such estimate made by the company so far. Institutional Shareholder Services (ISS), a major shareholder advisory firm based in London, also explained earlier their support of the deal. Investors may understandably be discomforted by the significant volatility in global spot prices for oil. It is worth recognizing, however, that the spot price today may be of very little value in assessing the strategic opportunity of a transaction whose benefits will be realized over decades, ISS told investors in a report.
The shareholder group has supported the deal from the get go, adding there is credible evidence that the price tag Shell has to cough up for BG s assets is reasonable. Given the compelling strategic rationale, and the significant positive economics to be realized within a relatively short time frame, support for the transaction is warranted, the advisory firm explained.
Other Side of the Argument
Some investors are still unconvinced the deal is a good idea in the current pricing environment. Oil has fallen below levels considered practical a year ago, and the much-awaited recovery has been pushed out far into the horizon. The deal may return benefits over decades, but most investors don t have such long investment durations. Standard Life Investment, one of the largest investors in Shell, has been vocal about its opposition of the deal. David Cumming, head of equities at Standard, recently said: We have concluded that the proposed terms of the acquisition of BG are value destructive for Shell shareholders. He added that his firm would be voting against the deal. Alex Griffiths of Fitch Ratings warned on Wednesday that Shell s AA credit rating could be downgraded if the BG deal completes, primarily due to the $20 billion cash consideration as part of the deal. This signifies one of the short-term problems the oil giant could face in pursuit of BG.
Overall, less than one-fifth of Shell s investors opposed the deal, implying there is a general optimism in the camp that long-term benefits of the deal are likely to overwhelm any short-term concerns. BG shareholders are scheduled to vote on the deal today, and a success at this step could see the transaction complete as early as February 15.
- ^ NYSE:RDS.A (www.bidnessetc.com)
- ^ OTCMKTS:BRGYY (www.bidnessetc.com)
- ^ Sunday Times (www.thesundaytimes.co.uk)