All that remains for Shell’s (LSE: RDSB) takeover of BG Group (LSE: BG) to become a done deal is for shareholders to vote it through at the end of this month (AGM).
I’m now having second thoughts about this, partly as a result of last week’s news, which saw Standard Life announce that it will vote against the merger at the upcoming meeting.
This announcement has prompted me to stop for a moment and ask if the transaction still makes sense.
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The problem?
There’s a strong argument to suggest that, for those companies that invest right the way throughout an economic cycle, average profits will be higher over the longer term when compared with those of companies that are more reluctant to invest.
This may be a sound argument, but in my view it shouldn’t be used as an excuse to indulge masochistic tendencies.
The offer price for BG shareholders already included a notable premium. However, with oil prices falling like they have since April ($67) and the offer price having remained fixed, this premium has been rising steadily for some time.
With little sign of a rebound from crude on the horizon, the transaction is beginning to look like an ‘impairment charge waiting to happen’.
More to the point, for it to benefit shareholders in the way that management says it will, Shell will need every dollar of its oil price assumptions to prove correct. The break-even assumptions included in the offer were: $67/bbl in 2016, $75/bbl in 2017 and $90/bbl in 2018-20.
The cash flow break-even is $50 per barrel.
More oil price woes
These forecasts may have remained an open question if it weren’t for the fact that western powers have now begun to lift sanctions against Iran’s oil industry, so a further increase in global supply could be imminent.
In the pre-sanctions world, Iran’s output was close to 3.5m barrels per day, equivalent to just over 3% of current global production.
Regardless of how long it takes to get back to that level, any notable increase in global supply will only delay the time at which prices either stabilise or begin to recover.
The net effect is that Shell’s price assumptions are probably out of the window now, if they weren’t already.
The takeaway
Stranger things have happened but the prospects of the deal being voted down by enough shareholders appear to be slim.
Standard Life seems to be alone in opposition to the transaction, while an army of corporate advisers continue to egg on both sets of management and shareholders.
However, private investors should consider this.
Dividend cuts have rippled throughout the commodities space like a wave of falling dominoes of late. This is while Shell paid out more in debt interest during the first nine months of the current year than it actually earned itself during the period.
When the game is finally up on Shell’s oil price fantasies, its profitability is squeezed further and management is forced to kneel before investors with a record impairment charge in hand, how much longer do you think the dividends will last?
How long do you think it will be before management is forced to tear up the pledge of a $25bn capital return ahead of 2018?
It may never happen, but I believe events of the last quarter have made it a threat that warrants consideration.
