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Shell’s BG Arbitrage Fades as Investors Look Set to Back Deal

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Screen Shot 2015-12-23 at 09.03.45By Rakteem Katakey and Ryan 25 JAN 2016

Royal Dutch Shell Plc is on the brink of completing its biggest acquisition as shareholders look set to back its purchase of BG Group Plc.

Risks to the deal completing have almost disappeared. The discount of BG’s shares to the offer price narrowed to a record low of 2.2 percent on Monday after some of Shell’s top shareholders and advisory firms backed the transaction this month. It was at 12.5 percent on Dec. 21.

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Shell’s acquisition, the industry’s biggest in at least a decade, came under scrutiny after oil prices fell by half from about $60 a barrel the day before it was announced in April. The slump, which Shell Chief Executive Officer Ben Van Beurden expects to be prolonged, previously kept BG’s discount to the offer from narrowing as some investors questioned whether Europe’s biggest oil company was paying too much. That’s changing as shareholders come round to Shell’s view on the long-term rationale of the purchase.

“It now looks like a done deal,” said Niels Lammerts Van Bueren, an Amsterdam-based portfolio manager at arbitrage fund Trz Trading BV. “Shell keeps saying it is a merger for the long term. And it should be looked at that way.” 

Trz Trading has increased its exposure to the arbitrage between BG’s shares and the offer since the end of December, looking to benefit from the deal closing as the risks narrow.

The wider the arbitrage spread, the higher the risk to the deal completing. For investors who believe the transaction will close, it’s an opportunity to buy BG stock and sell later for a profit as it rises toward Shell’s offer price.

Deal Logic

Investors including Norway’s wealth fund and Aberdeen Asset Management Plc, among Shell’s biggest shareholders, have backed the deal, saying the combination with BG works in the long term even though oil prices are currently low. Shell’s holders will vote on the transaction on Wednesday and BG’s the next day. Shell sees the deal completing Feb. 15.

Shell has “been clear in saying this isn’t a deal for the next three years, it’s a deal for the next 20 years,” said Christopher Wheaton, a director at Allianz Global Investors U.K. Ltd., which owns shares in both companies. “They’ve been on the road the last six months trying to convince shareholders that, yes, despite the short-term volatility in oil prices this is going to lead to a better Shell,” he said in a Bloomberg Television interview on Monday.

Shell in April offered 0.4454 of its B shares and 383 pence for each BG share, valuing the transaction at $70 billion and offering a 50 percent premium. As Shell’s shares have dropped with the oil price, the deal’s value has declined to $51 billion. BG is the only company to rise in the eight-member FTSE 350 Oil & Gas Producers Index since the deal was unveiled. This has reduced the premium to less than 10 percent.

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Shell says it’s better off with BG rather than alone in the downturn. It has justified the deal by saying cash flows will improve and enhance the company’s ability to maintain dividend payouts. The acquisition will also make the company the world’s biggest liquefied natural gas trader and increase its access to Brazil’s deepwater oil reserves. BG’s increasing oil and gas production also makes up for Shell’s declining output.

Yet crude’s collapse and the outlook for a protracted slump mean it will take Shell longer to break even on the acquisition. The company said last month it will break even with benchmark Brent in the low $60s and add to operating cash flow per share at $50 a barrel in 2016. Oil is currently trading at about $31 and cargoes for delivery in December 2020 are at about $49.

The deal will add to Shell’s cash flow even below $50 a barrel, Chris Cernich, head of special situations research at Institutional Shareholder Services, said in a Bloomberg TV interview in London. “It is a shrewd if not a perfectly timed acquisition,” he said. 

‘Compelling’ Rationale

Institutional Shareholder Services advises many of Shell’s largest holders. Earlier this month, it told investors to back the deal because it has “compelling strategic rationale” and there are “significant positive economics to be realized within a relatively short time-frame.”

Standard Life Investments is the only Shell shareholder that has so far publicly said it will vote against the combination, believing the acquisition to be “value destructive.”

“The vote appears divided,” said Richard Hulf, co-manager in London of Artemis Global Energy Fund, part of a group overseeing $32 billion for investors. “Our fund would vote for the takeover but I know some others may have voted against, mainly on the basis of current oil prices and the perception of an oversupply in global gas.”

Since low crude prices are a “very short-term phenomenon,” the deal should be valued at long-term prices of at least $60, he said.

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