The Shell takeover of BG has created a lot of buzz recently. With the oil price hovering under $40, there has been a lot of talk that this deal could collapse. There is constant chatter of whether or not Shell will go through with their takeover of BG. This dilemma has led to the market pricing BG at a discount to what it should do if the deal were to go through.
Here is what I mean. The conditions for the Shell takeover of BG is that Shell will pay 0.4454 RDSB shares + 383p for every share of BG. So is the RDSB Shell Share price is 1500 (£15.00) the BG share price should logically be 1051.51 (£10.51) as seen by the table below. (1500 *0.4454) + 383 = 1051.51
But this is not was is happening in the market. When the Shell price was 1500p the BG price was 961p. As you can see, by buying BG at this price, you get a discount of about 8%, or in other words, you buy Shell (RDSB) for a cheaper price of 1370, provided the takeover goes through.
Last month, I took advantage of this discrepancy and bought BG stock at 961p. If the deal goes through, I am electing to receive only RDSB stock a opposed to RDSB + cash. This will give me about 47 shares in Shell. Thus on my initial investment, I am getting shares in Shell for 1370 instead of the current market price of 1500.
This discrepancy has arisen due to the market having doubt over the deal. The market has priced in the risk of the deal not going through in the BG stock. Thus the BG stock is trading at a cheaper price that what it should do if you are certain that the takeover will go through. (If the takeover doesn’t go through, the BG share price will fall ).
As at the end of the Wednesday 6 January, the Shell and BG prices are 1504 and 955 respectively. The BG price should rationally be 1052. The discount is now just over 10% which has increased since I bought my shares. The increase on the discount may be as a result of the market thinking that the takeover deal will not go through.
Below is a table showing the prices it makes sense to buy into BG provided you feel the deal will go through.
The table below shows what the price of BG stock should be for a given price of Shell (RDSB). So if the RDSB market price is 1550 and the market price of BG is 980, this is below what BG should be as seen by the table of 1073. You can get an instant profit through merger arbitrage of 9% if the takeover goes through.
|Shell Stock Price (RDSB)||What BG Stock price should be|
Thus if you believe the Shell takeover of BG will happen, by buying into BG, you can get Shell stock at a cheaper price than you otherwise could. This is merger arbitrage and could be a dangerous game if you do not know how it works. It can be highly rewarding but if the takeover deal falls through, you will set to lose out as BG share price will take a dive and will no more have the acquisition premium it has had since the takeover bid was launched. In the event that the BG share price drops as a result of Shell pulling out, there is some solace for dividend investors in BG. BG currently pays out just over £600 million in dividends a year. The fee Shell has to pay BG for the cancellation of the BG deal is £750 million. This gives BG the ability to maintain its dividend in this low interest rate environment.
The merger arbitrage works on any takeover or merger deal where there is scepticism that is reflected in the market price.
Will Shells Takeover of BG go through.
If you asked me this question in December when I bought the stock, I would have said yes. But now, a month later I am a little sceptical on whether the takeover will go through or not. The oil price has remained low thus making the move less viable from Shells point of view and certain big investors in BG like Capital Group have sold out this week which suggest that they fear the deal will fall through,
In acquiring BG, Shell adds about 280,000 barrels of oil per day. Shell itself produces 1.4 million barrels of oil per day, and this acquisition adds 20% to Shell’s production totals. However, it does not add 20% to Shell’s profit levels, based on current oil prices. BG’s upstream projects don’t turn a guaranteed profit until oil hits $70 per share. That is why Shell is is hated right now now – it needs the price of oil to double from current levels in order for the takeover of BG to make financial sense.
The key date is January 27 which is the date the Shell shareholders vote. I think it is certain that BG shareholders all vote yes. It all rests now on the big shareholders of Shell. If they see oil prices rising in the near future, they will vote yes whilst if they do not, they will vote against the takeover and this might consequentially hit the oil price as the market will read into a no vote as big players thinking that oil will stay lower for longer. Some interesting times we have ahead.
A cheap way into Shell (RDSB)
If you have been following my journey to attain financial independence through dividend investing, you will know that I just recently bought shares in Shell. So why would I possible want more? Shell is a stalwart of a business and has fantastic economics. Its current price its cheap and thus I would like to my hands on as much Shell as possible without unbalancing my portfolio too much. If the deal goes through, I will have a yield of 9.1% on my £644 investment. Isn’t that fantastic. I will be getting £58.75 a year from the biggest integrated oil company in the world. Dividends can always be cut, but I do not envision Shell management cutting the dividend any time soon as seen by my post on Shell. But if oil stays at these levels for longer, a dividend cut becomes a big possibility. As always do your own research.
As mentioned, I do feel that the Shell stock is cheap relative to other oil majors. A number of reasons has led to this including the company calling it quits on projects in the Northwest–Alaska and parts of Canada–as the sustained environment of $40 oil has made it impossible to turn a profit on drilling. This resulted in a huge write-off that forced Royal Dutch Shell to report a loss of $6.1 billion in third quarter earnings (the first quarterly loss for the company in over a decade.).
Even though Royal Dutch Shell has had a disastrous third quarter, it is still one of only four non-refinery oil companies in the world that is able to support its pre-crisis dividend rate based on ongoing earnings. It has a massive cash hoard and has a stellar record of paying dividends.
If Shell maintains its payout of £1.25, the amount of income generated for just paying £15.00 per share is enormous. It really would be the equivalent of owning your own oil well. Even if the dividend remained static, you’d collect your full investment amount back in the form of dividends alone during the next 12 years. That doesn’t even speak to the turbo-charging effect of reinvesting Shell dividends, which could accelerate the arrival of that day you realize your stock holding paid for itself.
Even though Royal Dutch Shell is a slow grower, it tends to offer investors gobs and gobs of income that can be used to fund other investments or to improve your own lifestyle. Shell has delivered an annualized return of over 14% during the course of the 20th century despite having an earnings per share growth that was only over half that amount. Investors have always been concerned about Shells ability to grow the business and all the years of high dividend payments never quite got their due respect. History has shown that Shell is a truly wonderful business that has given investors a lot of income compared to the amount of their initial investment.
If the acquisition happens, I don’t plan on selling the shares in Shell I receive as part of the deal. I plan on keeping the shares in Shell and holding them for the long term as Shell is one of those companies that is perfect for any buy and hold investor. It is one of the best examples of the notion that you only need to get one decision right in your life to radically change your financial circumstances. Shell is a wonderful business and I would be stupid to sell it.