Currently Royal Dutch Shell A shares trade almost at par to Class B shares (RDSA LN at GBp 1496 vs RDSB LN at GBp 1501). In the absence of share buybacks till at least 2017 and once the BG deal situation is off the table (completed or lapsed), we would expect the discount of As to Bs to widen again to 4-6% levels. Hence we would suggest to go long RDSB LN and short RDSA LN in 1 to 1 ratio.

Although lower pay out profile (4-6% upside, 1-2% downside), this represents much lower risk and  better upside/downside profile than playing the BG/Shell deal spread (with 10% upside and 35%+ downside) going into last 1-2 months of the BG/Shell deal.

–          Difference between Shell Class A and Class B shares:

o   Main difference is 15% withholding tax on dividends on A class and no withholding tax on B shares

  • Class A: Dividends paid on Class A ordinary shares have a Dutch source for tax purposes and are subject to 15% Dutch withholding tax. Royal Dutch Shell is incorporated in England and Wales and tax-resident in the Netherlands..
  • Class B: There is no Dutch withholding tax on dividends on Royal Dutch Shell Class B ordinary shares or Class B ADSs provided that such dividends are paid on the Dividend Access Share pursuant to the Dividend Access Mechanism.
  • Although only A share sare eligible for scrip dividends, both A and B shares have same voting rights and dividend amounts.

–          Prior to the Apr-15 BG Group deal announcement,  A shares traded at average 4-6% discount to B shares (range 1-7% discount) :

o   Given withholding tax difference between As and Bs,  theoretically A shares should trade at a 10-15%  discount to B shares.

o   However Shell has been running significant share buyback programs (during full year Shell bought back about 87.7m shares or about 2.5% of outstanding As) and is always buying the lower priced line, i.e. the A class, keeping the spread tighter than it should: when Shell ceased its share buyback program end of January 2015, the spread widened from 2% to 4-5%.

–          But A vs B discount has tightened significantly (lowest since early 2012) and both lines are now almost trading at par on the back of Shell announcing its 65%/35% stock/cash acquisition of BG Group:

o   Because BG Group shareholders have option to elect either B or A shares, it was consensual that BG Group shareholders would elect the higher priced class, i.e. B shares. Hence the arb community set up the spread on the B shares, with large selling of the B shares, dramatically reducing the spread between the higher priced Bs and lower priced As.

  • From 2.7 deal announcement: ‘BG Shareholders will be entitled to elect to receive the share component of the Consideration in the form of Shell A Shares, as opposed to Shell B Shares, at the same exchange ratio.’

–          HOWEVER THIS SPREAD SHOULD WIDEN OUT AGAIN TO 4-5% PRE-DEAL LEVELS:

o    ON DEAL CLOSE:

  • No more arb pressure:Upon 1H16 BG deal closing, the spread setting B class sell pressure  will have ceased .
  • Absence of share buybacks: Shell announced it would only commence a share buyback in 2017 (subject to progress with debt reduction and Brent oil prices recovering towards the middle of Shell’s long term planning range of $70-$90-$110 per barrel).

o   ON DEAL BREAK:

  • Should deal break, arbs will have to buy back their shorted Bs in large size, hence putting significant buying pressure on the Bs.