Robert Sutherland-Smith Sticks with Shell after BG Bid

In my recent musings about the relative charms of BP (BP.) and Shell (RDSB) equity, I concluded that I preferred BP because Royal Dutch could make a bid for BP. Earlier this week, Royal Dutch Shell blew that bit of rationalisation out of the deep blue waters of speculation, by saying that it was to pay £47 billion by way of an agreed bid for BG (BG.) equity. So, is a bid for BP now off the table? Well at least by Royal Dutch Shell for the time being. That still leaves Chevron as a possible, rumoured predator. So it’s instructive to see what Shell was was prepared to pay, and for what…

BG Group plc is a natural gas company. The company is engaged in the exploration, development and production of natural gas and oil, and operates in two business segments, including upstream and liquefied natural gas (LNG) shipping and marketing. The company explores to develop, produce and market gas and oil around the world.

The Upstream business segment covers exploration and production activities plus liquefaction operations associated with integrated LNG projects. The company purchases, ships, markets and sells LNG. The LNG Shipping & Marketing segment covers these activities, as well as the group’s interests and capacity in regasification facilities.

Royal Dutch Shell, assuming that £47 billion is worth $71.4 billion, has paid 3.7 times last year’s annual sales revenue figure; 1.17 times last year’s total asset figure of  $61.84; and 2.4 times last years balance sheet net asset value. One report tells us that this means Royal Dutch Shell will increase its gas and oil reserves by a quarter and production by one fifth.

If we were to value BP on these three separate ratios, we could infer bid values for BP ranging from $263 billion to $1,300 billion (the latter is based on price to sales, which is obviously not applicable given that BG was a growth business whereas BP is not). On most metrics, BP looks undervalued at is current (last seen) market capitalization of around $124 billion. This of course is not scientific to any degree because it is comparing apples with pears.

The thing which is almost certainly driving the bid for BG by Royal Dutch Shell is the example of BP when it went oil hunting under the waters of the Gulf of Mexico. Deep sea prospecting with all of its financial, ecological, legal and political contingent liabilities is the stuff to give the boards of big integrated oil companies nightmares. It was presumably a blessed relief and a God send that the massive falls in the price of crude oil not only made such exploration uneconomical but also brought the BG share price down to make it possible to buy its onshore prospects in the US and Brazil at a low point in the longer term oil price cycle.

If this bid succeeds, it will have the effect of improving the quality of Royal Dutch Shell’s prospects. The BG share price seems to be below the bid value. The bid seems to offer a high and probably reliable dividend yield which Shell’s management will be keen to maintain even if its demand for cash with which to consummate the bid is looking high.

All this is going on at a low point in the share price cycle so for that elementary reason I think that Royal Dutch shares, along with the dividend yield and lower risk profile (cum BG) look attractive. This deal is being done on the floor of a cycle not at its peak. Bidders can afford to pay premia for long term prospects. Stick with Shell is my view and hope the bid succeeds as it probably will with a lot of institutional investor sighing – except those owning BG equity.