Jan

8

 On January 27, shareholders of Royal Dutch Shell will vote on the company's plan to buy BG Group PLC (the upstream remnant of Margret Thatcher's privatized British Gas).

If you are a merger arbitrageur, you are praying that the RDS shareholders will shoot themselves and vote yes, as the deal spread is very wide.

If you are a shareholder in RDS and have carefully studied the assets, forward prices, and assumptions, you have concluded that this deal is likely to be remembered among the largest destructions of shareholder value in the history of the world. I reached this conclusion several weeks ago. Today, Standard Life, RDS' 11th largest shareholder concluded the same thing and said they will vote "no."

Perhaps if you are the analyst at Institutional Shareholder Services (ISS) who recommended that shareholders vote in favor of the deal, you might be assured of a future job at Goldman Sachs, JP Morgan or Rothschilds after the deal closes — as the investment banking success fees will likely be extraordinary.

But — where are the activists? They can easily and rightly point out that there are numerous other assets around the world that RDS can buy at much better prices ; with a better risk/reward…

THIS DEAL IS EERILY REMINISCENT OF BANK OF AMERICA'S KEN LEWIS BUYING MERRILL LYNCH DURING THE FINANCIAL CRISIS OF 2008. The day that this RDS deal closes, billions of RDS equity will be destroyed.

Are we witnessing the downside of billions of dollars of passive index money blindly following the ISS pied piper over a cliff?

Carder Dimitroff writes: 

This deal is complicated. Most shareholders lack enough information to form an opinion. While I'm on record as being concerned about the liquefied natural gas industry as an investment, I have no opinion on this deal.

This deal is about BG and RDS's natural gas portfolios and forward values of any combination. To know future values requires a full understanding of their book of contracts, their hedges and their speculative accounts. It also requires the analyst to be certain about future market conditions.

Here's what I know:

1) By definition, liquefied natural gas is an international commodity. There are few to zero domestic markets for this commodity.

2) RDS will likely become the <production> cost leader in Western Pacific's liquefied natural gas markets.

3) BG could become a cost leader in the Atlantic liquefied natural gas markets. BG bought 20 years of supply in the US market and must sell in another market. Those markets are not correlated. It's likely BG's 20-year purchase agreement is unhedged. Nevertheless, the deal currently has a substantial gross margin. If oil prices increase, their margins will likely increase.

4) Combining portfolios can sometimes offer surprising results (good or bad). Combining Pacific and Atlantic portfolios could create substantial value. It also could create interesting hedging opportunities, which in turn create value. Without understanding details of RDS's portfolio strategies, it would be difficult for most shareholders to correctly value the combined portfolio.

5) Liquefied natural gas can be used as a substitute for coal. Under current market and political conditions, natural gas is currently an economic alternative to coal.

6) Finally, there is a speculative element to liquefied natural gas industry. Consider the pressure to reduce coal consumption. Also, consider desperate gas markets. If Europe and Asian markets can replicate UK and US markets, indexing natural gas to oil prices could be defeated. If defeated, international natural gas markets could open up with RDS as the clear leader.

Apparently, people looked at portfolio details and they have concluded the BG-RDS merger is a good deal. Other experts looked at the same data and concluded the merger is a bad deal. I don't know. 


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