Royal Dutch Shell (RDS.A) and U.K.-based BG Group have announced this morning -- following a story in the Wall Street Journal last night -- that BG has agreed to be acquired by Shell in a cash and stock transaction. Shell is paying a hefty premium -- 50% above the current BG share price, which would value BG at $70 billion, representing one of the largest oil/gas deals in recent history. The deal will add 30% to Shell's reserves, 20% to current production and 27% to its LNG liquefaction volumes.
Shell has come out and said that it has identified $2.5 billion of annual synergies between now and 2018 ($1 billion reduction in underlying costs and $1.5 billion from reduced exploration activities). The company is also expecting the deal to be mildly accretive to earnings per share, but strongly accretive to cash flow in 2016. Following the deal, we expect that by 2018 Shell will become the largest publicly traded oil & gas producer at 4.2 mbd, surpassing Exxon Mobil (XOM).
We think the prime attraction of BG for Shell is its LNG position, which makes up 40% of the company's current asset value. Shell immediately increases its leading LNG market position by about 33%, and the BG LNG portfolio is set to double by 2019. Beyond the volume addition, Shell also increases its logistical capabilities. Both companies have offtake from the Atlantic LNG facility in Trinidad and at Nigeria LNG, while Queensland Curtis LNG (QCLNG) increases Shell's exposure to Australian LNG and adds to its leading position in the highest-priced Pacific LNG trading market. Other operational benefits include BG's North Sea assets, its position in Karachaganak in Kazakstan, and less important assets in India, Thailand, North Sea and Egypt.
The transaction also makes Shell the leading foreign oil company in Brazil, combining Shell's existing production operations at BC-10 and its equity in the giant Santos Basin Libra field with BG's pre-salt Santos position. We estimate that BG's Brazilian portfolio will grow over 250% between now and 2020, and will become the key underlying production growth driver for Shell.
Importantly, CEO Ben van Beurden and CFO Simon Henry were both keen to emphasize the potential for significant free cash flow generation of the combined group and took the unusual step of confirming the planned dividend for 2015 as unchanged y/y at $1.88 per share and at least that level in 2016. Management also reiterated that it expects to commence a $25 billion share buyback program in 2017 to help offset the dilution from the existing scrip dividend.
Overall, we have a neutral view on the deal as we try to reconcile the expensive price with the transformational nature of the assets it has acquired. BG provides Shell with a large and lucrative asset base, premium LNG (which is going to be in demand in a major way in Asia) and a chance to get much larger in Brazil as some say it has the best assets there after the hobbled Petrobas.
We fully understand the strategic drivers of the transaction, and believe the fit is an excellent one for Shell. The imperative now becomes for management to convince the market of the financial implications: near-term earnings dilution; a significantly more levered balance sheet; and a higher priority for debt reduction vs. dividends on cash utilization. Our target remains $75.