Royal Dutch Shell is forking out EUR 64.3 billion for British BG in the biggest takeover in the industry in the last ten years, and is paying a 50% premium on its current share price. While this takeover is the biggest M&A deal this year and likely to remain so, it will certainly not be the last takeover in the energy sector.
Dirk Hoozemans, analyst for the Robeco global equity team, is not unduly surprised by the takeover, but praises Shell's timing and patience. "A new consolidation round has long been the subject of speculation. Companies such as Shell and Total have strong balance sheets and can now make use of plunging prices to cut cheaper deals."
And many smaller companies, up against the large oil majors with their strong cash positions, are potential prey for takeovers. These companies are clearly less keen to be picked up by large oil concerns in light of the current stock prices – a direct result of the strong decline in the price of oil. "There is a power game going on. But if the oil price continues to remain low and cash flows dry up, the smaller companies' resistance will crumble."
Hoozemans refers to Shell's good timing. The last time there was a big takeover by an oil major, in comparison, when competitor Exxon bought gas producer XTO in 2010, natural gas prices were considerably higher. With this deal, Shell is investing in two growth areas, says the analyst. "First, they are buying deep-water projects and reserves, in which BG previously invested substantial amounts and which have already reached an advanced stage of development. There are large finds under the salt layers of Brazilian waters. These are assets that, within a period of two years, will deliver large-scale production growth and cash flow." The second area Hoozemans refers to is BG's extensive LNG activities, mainly in offshore Australia, where Shell also owns large gas reserves.
This takeover is not a desperate move, but rather one born of luxury, Hoozemans believes. Above all, the deal is one that will strengthen Shell's existing portfolio in two important areas: Shell will become the second of the super majors and will double its LNG activities from 2018. In addition, it will add to its production and reserves in deep-water Brazil, where the company has had relatively little exposure.
The question is what action other oil majors will take now that Royal Dutch has pulled the trigger. The share prices of small oil companies have shot up in response to this news. This is not surprising, as taking BG removes the last large takeover target from the market. Hoozemans expects further takeover activities. "There are sure to be more M&As in this industry. But this will mainly involve smaller companies with weak balance sheets being absorbed by large companies with strong balance sheets."
Whether the takeover of BG will prove to be a financial success for Shell in the long run clearly depends in part on how the oil price develops. Prices for natural gas are linked to oil prices. "Shell is counting on an oil price of USD 90 per barrel from 2018, thereby buying into growth, which will pay off even more when the oil price rises." This also partly explains the 50% premium Shell is paying. "Not only does the takeover pay for present cash flows, but also for tapping future reserves. The 50% premium is close to the net asset value being attributed to BG."
Hoozemans thinks that Shell's competitors will in future want to augment their portfolios with smaller acquisitions. "These smaller companies are easier to absorb than one the size of the BG deal." And, as a result of earlier consolidations in the sector – BP bought oil companies Arco and Amoco in the year 2000; Exxon absorbed Mobil; and Chevron and Texaco amalgamated – the game between the biggest players has been played out.
The recent increase in the share prices of small oil companies suggests that many investors are already anticipating further takeovers. This is an understandable reaction, but on the face of it, not particularly sensible, Hoozemans believes. "As an investor it is wiser to buy stocks of companies with a sound business structure, strong management and solid assets, without immediately speculating on a takeover. But some investors are now buying baskets of ten small companies in the hope that there is one winner among them. However, a strategy of this kind costs both money and patience."
Hoozemans is positive on the future of the biggest oil concerns. While a few years ago, the outlook was not bright for their finite business model (declining reserves, all easily accessible resources used up and the only new projects in geopolitically challenging regions or in expensive deep-sea schemes), the future is looking fairly bright now.
According to Hoozemans, the shale gas revolution has shown the doom thinkers to be wrong. "Shale gas and oil have proven easier and cheaper to extract than ever imagined. People underestimated technological innovation." With its takeover of BG, Shell is once again demonstrating that the oil sector is alive and kicking and that growth is still feasible.
"It's a question of doing the math to see if growth can be achieved more cheaply by drilling or by acquisition. Shell – already a global player – is just strengthening its position. And not unimportantly: dividends are not suffering either."
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