If you want to own Royal Dutch Shell stock, a cheap way of buying the B shares has opened up but you might want to think twice before calling your broker.
The route is via BG Group, the U.K. gas and oil explorer that succumbed in April to a £47-billion ($94-billion) cash-and-shares bid from Shell. It was the culmination of a courtship that has lasted more than a decade and some critics then wondered if Shell's impatience to get its hands on BG's huge oil and gas reserves caused it to pay just a little too much.
Shell's uncharacteristic chutzpah (the last time the company did such a bold corporate deal was the joint venture with Royal Dutch Petroleum a century ago) is today exposed to full view by the languishing oil price. The value of the cash and shares bid is £11.32 but you can buy BG stock in the market for just £9.93, a 12-per-cent discount to Shell's offer. With the fixed cash element of the bid, it means that a BG investor could today buy into Shell stock (assuming completion of the takeover) at a very substantial discount to current prices.
Such a discount to the takeover price (and it has recently been as high as 13.7 per cent) raises the disquieting prospect for BG investors that the market believes the Anglo-Dutch firm may be having second thoughts about its gamble. This is categorically dismissed by Shell, and management is at pains to assert that the takeover makes financial sense despite the current Brent price, which is about $20 (U.S.) below Shell's long-term minimum Brent planning forecast of $70. However, they may be protesting too much – in a recent comment, Shell's boss suggested that it made sense at any oil price.
Were Shell to renege on its undertaking to bid for BG, it would pay a penalty of £750-million. It's not a huge sum for such a large company and, therefore, the issue is not the penalty but the financial risk to Shell of either overpaying for oil reserves or of missing the opportunity to fill the tank in a price downturn. The other risk, of course, is to Shell's chief executive officer, Ben van Beurden, who has nailed his reputation to both the takeover and to Shell's big annual dividend payout.
Like all the oil majors, Shell is a key component of any equity income portfolio. The company has never missed a payout and it has survived many a downturn but a glance at the current yield on Royal Dutch Shell B, above 7 per cent, suggests a degree of nervousness. According to Sanford Bernstein, the top eight European oil stocks are rated at more than double the average market dividend yield. The question, as the investment bank puts it, is not whether Shell will survive this downturn but whether it can do so without tampering with the payout to shareholders. Within that question lies the BG bid and whether a much bigger Shell could generate enough cash to satisfy the generous expectations of the enlarged shareholder base.
Sanford Bernstein reckons that more cost cutting and crimping the capital expenditure bill will do the trick but the oil majors have been profiting heavily from fat refining margins and those will slim in the coming year. Shell may find it difficult to cut its capital expenditures, having inherited some monster deep-water projects from BG Group. It can always sell some assets but in the current climate that could prove to an unprofitable way of shoring up a dividend.
Shell is not the only company wrestling with an expensive takeover. Glencore, the miner and metals trader, is in an even more difficult place, having acquired rival Xstrata ahead of the recent commodity downturn. Glencore was given a warning by Standard & Poor's of a possible debt rating downgrade. The company has lost two-thirds of its stock value since its initial public offering four years ago.
Glencore is in a much worse place than Shell; the oil company is still highly profitable, has low borrowings and, unlike the miner, it has in its refining arm a business that can work as a countercyclical play in low commodity prices. Glencore's widely touted ability to play the falling market with its commodity trading business has proven to be less effective.
Still, Shell cannot afford to make a mistake with BG Group, probably the biggest gamble it has ever taken. It is in a good position to renegotiate – BG's investors are doing very well out of Shell but if the larger company pulls out, BG investors will be in a very bad place indeed.
Carl Mortished is a Canadian financial journalist and freelance consultant based in Britain.
Carl Mortished