Royal Dutch Shell Plc is on the brink of pulling off its biggest acquisition. Yet the widening discount of target BG Group Plc to the offer price shows that a further steep drop in oil prices could still put the deal in doubt.
BG traded 12.5 percent below Shell’s bid price on Dec. 18, the biggest discount since early September, compared with a 6.4 percent gap on Dec. 4. While BG shares soared when news of the deal broke eight months ago, they’ve since tumbled more than 20 percent as oil prices slumped.
If benchmark Brent crude sinks to the mid-$20s a barrel, the transaction may fall through, said Philip Lawlor, a strategist at Smith & Williamson Investment Management LLP in London, which owns shares in both Shell and BG. Trz Trading BV’s Niels Lammerts Van Bueren said it “all depends on the oil price.”
Most money managers expect the deal to proceed with oil at current levels. Brent is trading at about $36.14 a barrel in London, having lost two-thirds of its value since June 2014 amid a global supply glut. Shell in April offered to pay 0.4454 of its B shares and 383 pence in cash for each BG share in a deal valued at $70 billion. A decline in Shell’s stock has cut that to about $53 billion, according to data compiled by Bloomberg.
There are “high risks” that oil may fall further, Goldman Sachs Group Inc. said Dec. 17, while Citigroup Inc. said U.S. crude may fall into the $20s if storage tanks start to fill up before producers curb output sufficiently.
Shell last week won Chinese antitrust approval to buy BG, completing the fifth and final precondition to the deal. The companies said Monday they expect final shareholder votes at the end of January. Shell has justified the purchase by saying BG’s assets, which will make it the world’s largest liquefied natural gas company and a major player in Brazil’s vast oil fields, far outweigh the risks.
Olivetree Financial Ltd., a London-based brokerage that specializes in mergers, has invested almost $1 billion in recent weeks in the spread between BG stock and the offer price. BG is currently trading 10.4 percent below the bid.
“The only impediment is the shareholder vote,” said Mark Kelly, Olivetree’s chief executive officer for Europe. “We’ve been buying massively in the past weeks for clients looking to benefit from the arbitrage because they think the deal will go through.”
Investors can earn a profit by purchasing BG shares now and becoming Shell shareholders when the deal closes. The wider the spread of BG stock to the offer price, the higher the return and also the risk.
“The arbitrage spread will be a function of the oil price from now on until the shareholder vote,” Trz Trading’s Van Bueren said. His fund reduced its exposure to the arbitrage in the past week, taking profit along the way. He plans to buy in again if the spread widens more and oil prices don’t fall further.
Shareholders are likely to vote on the acquisition on Jan. 27 and Jan. 28. Shell requires the backing of 50 percent of its holders. In BG’s case, votes in favor must represent at least 75 percent of the total value of BG shares.
Shell has promised investors $3.5 billion of operational cost savings related to synergies from the deal, and says the takeover will add to earnings per share and cash flow from operations. The outlook for the acquisition got a boost in October after BG raised its oil and gas production forecast for the year at a time when Shell’s output has stagnated.
“It would be a huge surprise should the deal fail to get the required shareholder vote,” Olivetree’s Kelly said. Nevertheless, the 65 percent probability of success ascribed by Olivetree’s model is lower than the 75 percent estimated in September. That’s because it’s the end of the year and arbitrage funds are struggling to find capital to add to positions in BG and narrow the spread, Kelly said.
“The oil price is raising significant question marks about the viability of this transaction,” Smith & Williamson’s Lawlor said. “What the arbitrage spread is factoring in is, it’s not inconceivable if there’s another sharp spike down in oil prices — crack through $30 towards $25 — there has to be a pain threshold beyond which the board would have to turn around.”