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Shell Makes A Huge Bet On LNG and Pre-Salt

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Screen Shot 2015-04-08 at 08.12.04Shell Makes A Huge Bet On LNG and Pre-Salt

Anglo-Dutch oil major, Royal Dutch Shell Plc., recently announced plans for a mammoth – $70 billion – acquisition of BG Group Plc. to further extend its leadership position in the global LNG (liquefied natural gas) market and increase its exposure towards the exploration and development of deepwater hydrocarbon reserves, primarily the pre-salt reserves offshore Brazil.

The company plans to acquire BG Group in a cash and stock deal valued at 1,350 pence per BG share. The company will pay BG shareholders 383 pence in cash and 0.4454 class B shares in itself for each share of BG held.

This translates into a total valuation of around 47 billion pounds or $70 billion – at Shell’s closing price on April 7th (the day before the deal was announced) – which represents a 52% premium to the 90-day volume-weighted average trading price for BG?s stock.

The company expects to realize annual pre-tax cost savings of around $2.5 billion by 2018. After adjusting that figure for the post-tax operating cash flows impact, and the dilutive effect of the deal, it would mean annual cash inflows of approximately $1.25 billion for Shell’s current shareholders, starting in 2018.

If we assume that these cash flows will continue in perpetuity, it would translate into a value addition of around $8.75 billion for its current shareholders at the time of the deal, which is just a small fraction (36.5%) of the total premium being paid by the company.

Therefore, we believe that while Shell?s broader strategy of acquiring BG to increase its focus on LNG and deepwater development projects is spot on, it has probably valued the target company a bit too aggressively and generating incremental returns from this investment might not be an easy task, at least in the short to medium term.

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