Royal Dutch Shell and BG Group case

study
Analyze the clients company
Large-cap FTSE 100 blue chips like Royal Dutch Shell (LSE: RDSB) are considered to be
relatively safe investments.
Unfortunately, Shell has been trying to go against this belief over the past year. During the
past 12 months Shell has taken on three high-risk projects, all of which could cripple the
company if they dont go to plan.
As a result, investors have turned their backs on the oil giant and Shells shares have
underperformed the FTSE 100 by a staggering 25% over the past year.

Three big bets

None of Shells three multi-billion dollar bets is without risk. For example, the most
controversial of them is Shells Artic drilling plan. So far, despite operational and
environmental headwinds, Shell has spent $8bn developing wells off the coast of Alaska, but
despite the huge expenditure, no oil has been found yet.
The second bet is Shells proposed strategic alliance with Russian energy giant Gazprom.
Two joint projects have already been announced, including an expansion of Shells LNG
export project in the Russian far east.
But the largest, and potentially most costly of the three bets is Shells $70bn deal to
acquire BG Group (LSE: BG).
Why does the client want to acquire? Potential reasons could be the following:
(a) Strategic (market position, growth opportunities, diversification of product portfolio)
Shell executives said the combined group will have two strategic growth businessesdeep
water oil and integrated gasthat could potentially each generate $15 billion to $20 billion of
cash flow from operations a year.
The planned acquisition represents another step in Shells transformation from a company
that mostly extracts crude oil from the ground to one that produces more gas than it does oil.

The roots of the change can be traced back a decade, when Shell was regrouping from a
financial scandal that saw its CEO leave and regulators fine the company for overstating its
reserves.
In the aftermath of the meltdown, Shell invested heavily in natural gas and now says that
integrated gas projects, in which Shell controls the extraction, shipping and end sale of
natural gas, give the opportunity for long, steady profits.
BGs gusher represents a big turnaround after years of under delivery on its own output
targets. It also underscores Shells bet that output from BGs stakes in highly prized oil fields
in offshore Brazil would start ramping up this year and that facilities at QCLNG would come
onstream as planned, bringing with it a big wall of cash that the Anglo-Dutch company hopes
to tap into.
(c) Synergies/value creation (cost saving opportunities such as economies of scale, crossselling, brand)
The Anglo-Dutch energy company has told investors and analysts that so-called value
synergies benefits that cannot yet be quantified under City takeover rules are likely to
be a multiple of the $1bn in annual projected savings from merging head offices and other
cost-cutting.
They suggested that the enlarged groups Brazilian deepwater oil portfolio and its combined
LNG trading and marketing operations would lead to economies of scale.
These would include reduced procurement and supplier costs in Brazil and, in the trading
arm, savings on shipping and logistics.
(d) Undervalued (ineffective management, unfavorable market, and the client has the power
to bring the target company to its potential value)
Shell is buying BG and its surging production levels just as its own oil-and-gas output is on
the decline. In its own second-quarter earnings on Thursday, Shell said its production had
fallen 11% compared with last years second quarter, to about 2.7 million barrels of oil
equivalent a day. In 2014, it replaced only about a quarter of its reserves with new
production, among the lowest ratios of the big oil companies.

Analyze the target industry

Potential questions to assess are:

Can the market be segmented and does the target only play in one of the segments of the
market?
How big is the market?
$1.73 tn = total reserves of 50 largest companies
Petroleum is vital to many industries, and is of importance to the maintenance of
industrial civilization in its current configuration, and thus is a critical concern for many
nations. Oil accounts for a large percentage of the worlds energy consumption, ranging from
a low of 32% for Europeand Asia, to a high of 53% for the Middle East.
Other geographic regions' consumption patterns are as follows: South and Central
America (44%), Africa (41%), and North America (40%). The world consumes 30
billion barrels (4.8 km) of oil per year, with developed nations being the largest consumers.
The United States consumed 25% of the oil produced in 2007.[1] The production, distribution,
refining, and retailing of petroleum taken as a whole represents the world's largest industry in
terms of dollar value.
Governments such as the United States government provide a heavy public subsidy to
petroleum companies, with major tax breaks at virtually every stage of oil exploration and
extraction, including the costs of oil field leases and drilling equipment.
What are possible threats?
The ground in the oil patch has shifted dramatically. The forecast for the industry is
extremely different today compared with how it looked just a couple of years ago, when the
fundamentals of the oil industry were controlled by cartels. That traditional structural
discipline has been replaced by a systemic imbalance marked by vastly increased supply and
receding demand growth. Global economic weakness (in particular, slower growth in China
and continuing financial woes in Europe); tougher fuel economy regulations; more viable
forms of alternative energy; and the development of extraordinarily efficient engines on
equipment as varied as cars, earthmovers, and power plants have all combined to
dramatically curtail the need for oil. Meanwhile, robust new reserves, especially of shale oil,
in numerous regions around the world are glutting the market.
The tie-up is a bet that countries like China, India and others in the developing world will
move toward cleaner burning fuels like natural gas instead of coal amid growing pressure to
curb emissions. And it is a gamble that Asian markets will come to rely on U.S. exports of
the product, when the first shipments leave the countryexpected sometime in late 2015 or
early next year.

Analyze the target company

After analyzing the target industry, understand the target company. Try to determine its
strengths and weaknesses (see SWOT analysis) and perform a financial valuation to

determine the attractiveness of the potential target. You are technically calculating
the NPV of the company but this calculation likely is not going to be asked in the interview.
However, having the knowledge of when it is used (e.g., financial valuation) is crucial.
Analyze the following information to determine the market attractiveness:
BGs gusher represents a big turnaround after years of under delivery on its own output
targets. It also underscores Shells bet that output from BGs stakes in highly prized oil fields
in offshore Brazil would start ramping up this year and that facilities at QCLNG would come
onstream as planned, bringing with it a big wall of cash that the Anglo-Dutch company hopes
to tap into.
The developments in Brazil and QCLNG are big complex projects that were hampered by
delays in the early stages, but the company said last year they would be ramping up in 2015.
Once an investor darling for its exploration successes and rapid production growth, BG fell
out of favor as the company was rocked by a series of profit warnings and production
downgrades.
The company grew rapidly in the early 2000s but its output stalled in the middle of the
decade. Frank Chapman, BGs chief executive until 2012, had predicted the company would
produce 1 million boe/day by 2015.
BG is now above the 700,000 barrels a day mark for the first timean achievement that
comes at an inopportune moment with oil prices hovering around $50 a barrel, down more
than 50% from their peak last year.
The companys underlying earnings, or profit after tax and excluding exceptional items such
as disposals and impairments, declined 65% in the second quarter to $429 million from $1.21
billion a year earlier. Analysts had expected net income of $315 million.
Related softness in prices for liquefied natural gas also hit BGs income, even as the company
delivered eight more cargoes of the fuel versus a year ago. Revenue was down 28% at $3.95
billion compared with $5.51 billion in the same period a year ago due to the fall in oil prices.
Our upstream business clearly felt the effect of lower oil prices, Mr. Lund said.

BG moved its full-year production guidance to the upper half of its range of 650,000-690,000
barrels of oil equivalent a day.
Earnings per share decreased 65% to 12.6 cents a share.

Analyze the feasibility of the M&A

Important questions here are:

Is the target open for an acquisition or merger in the first place? If not, can the competition
acquire it?
Yes especially in recent times where M&A shores up firms against falling prices.
Are there enough funds available (have a look at the balance sheet or cashflow statement)? Is
there a chance of raising funds in the case of insufficient funds through loans etc.
To win over shareholders, Shell pledged cost savings of $2.5 billion, asset disposals of at
least $30 billion within four years and a giant share buyback of $25 billion from 2017 to
2020.
Shells B shares, the class of stock being used to finance the deal, fell as much as 8.7 percent
in London, the biggest intraday decline since 2008. The A shares dropped 5 percent.
BG shares rose as much as 43 percent to 1,300 pence.
Shell snaring BG disrupts the prevailing view among analysts and bankers who had expected
merger activity in the industry to remain quiescent until later this year or even 2016.
The tie-up could presage a repetition of the wave of deals a decade-and-a-half ago that rocked
the oil patch and created todays so-called supermajors through deals that saw BP Plc buy
Amoco Corp. and the creation of Exxon Mobil Corp.
Shell was advised by Bank of America Merrill Lynch and BG worked with Goldman Sachs
Group Inc. and Robey Warshaw LLP.
Is the client experienced in the integration of acquired companies? Could a merger pose
organizational/management problems for the client?
Shells track record of executing on acquisitions has not exactly been stellar over the past
decade, said Michael Hulme, commodities fund manager at Carmignac Gestion. To assume
that Shell can pay a 50% premium for BG, and extract significant synergies, deliver value for
shareholders, and maintain a dividend on an expanded shareholder base would require a
more-than-healthy degree of optimism.
Are there other risks associated with a merger? (for example think of political implications
and risks of failure, like with the failed merger of Daimler and Chrysler)

Shell agreed to buy BG at a 50% premium to its Tuesday share-price close. BG shareholders
will get a 19% stake in the new company after the deal closes, likely in early 2016. To make
it palatable to investors, Mr. van Beurden said the company would increase its dividend to
$1.88 a share and launch a share buyback program of $25 million in 2017.
Still, Shells shares closed 5.3% lower in London, while BG stock ended 27% higher. Some
analysts and investors were skeptical that Shell, which sat out megamerger waves in the past
and has focused on exploration growth instead, could manage the acquisition.
Investors were skeptical of the stock and cash acquisition, which isnt expected to boost
earnings per share until 2017. The price of the class of share being used to buy BG fell the
most since 2008 on concern the company is overpaying.
Indeed, the deal is expected to be cash generative from the start and synergies achieved
should only improve cash generation over time. Moreover, Shell is planning to sell $30bn of
unwanted assets from its portfolio to fund the deal. These assets are likely to be low-return
assets already earmarked for sale.
So, while Shell may have to take on debt to fund the BG deal in the short-term, over the next
few years management will be able to rebuild the balance sheet.