We believe a long position in BG/ LN at current GBp 1150-1180 levels
represents an attractive short-term trading buy given it is a play on
three drivers of upside, namely 1) tightening of the announced BG/RDSB
deal spread which currently is trading at more than 10% pa; 2) some
reversion of the aggressive 10% price drop in RDSB; and 3) still
limited but present interloper risk.

Given the large institutional selling in BG, BG/RDSB deal spread at
10% pa (on Feb-16 closing) is currently much wider than all the other
long dated European deals which on average trade around 5-6% pa. Once
some of these sell flows will dissipate in the near term, we believe
this spread should largely trade in line with these other European

Given deal offer terms for BG largely consists of RDSB stock (70% of
offer consideration), long BG is equally a cheaper way of getting long
exposure to RDSB LN: we believe that RDSB’s 10% drop since the deal
announcement is largely exaggerated given a) RDSB dividend yield story
largely remains intact (RDSB currently trades at 2015e 6.4% yield vs
other majors at 5.6%); b) RDSB should see multiple expansion through
the acquisition of BG’s growth profile, c) earnings accretion should
flow through on the back of announced synergies.

Although we believe the chance of a counter in the near term is small,
there are still number of arguments why it is impossible to completely
rule out any potential interloper risk (mainly from XOM) – especially
as deal is structured as a long dated 10-15 months UK Scheme where
there is some inherent value that the chance of an interloper might
increase should oil pricing materially improve before the end of the

UPSIDE: When BG/RDSB deal spread would tighten to 6-8% pa levels, and
RDSB LN share price appreciate by 5%, upside BG/LN is 5-7%.

DOWNSIDE: Should Shell price break aggressively below the technical
GBP 20 levels (RDSB hasn’t closed much below that level since 2011),
we would look to cut our reduce our position, implying near-term
downside would be at worse about 2%. Full deal break downside is
about 21% to GBp 910 levels.


– BG/RDSB spread trades at 9.4% net spread or about 10.5%
annualized on Feb-16 closing:

o Similar European deals with long timetable(s) typically trade in
the 5-8% pa range (eg TNT/FDX at 5%, CSR/QCOM at 5%, INXN/TCY at 8%,
WDF/DUFN at 3%)

– At deal announcement, spread opened up very tight (around
2-3% pa) but significantly widened over the course of the announcement day and has stayed wide on the back of i) large institutional
flow back in BG (BG traded almost USD 2bn or about 4% of the company’s
stock), and b) arbs setting up at too tight levels on back of initial
excitement regarding probability of an interloper:


– Although deal requires regulatory approvals from EC,
Brazilian CADE, China MOFCOM, Australian Foreign Investment and
Australian Antitrust, there is only timing risk associated with these
approvals (mainly from Brazil, MOFCOM and Australia FIRB), and no
regulatory block issues given:

o a) deal represents acquisition of foreign UK company by foreign UK company

o b) Shell is already a well-known player and operator in the
respective geographies where BG operates

o c) Shell has been obtaining all the above approvals in some of the
other large scale transactions it has done in the past in those main
jurisdictions of Brazil and Australia (eg acquisitions of Libra in
Brazil in 2013, Arrow Energy in Australia in 2010,…)

o d) acquisition of BG by Shell actually benefits (local) Australian
economy as Shell will most likely activate its Arrow LNG project again
as it can now connect to BG’s QCLNG project (as it had to mothball
recently its USD 20bn Arrow LNG project in Queensland)

– No oil price MAC risk: Deal is structured as Scheme under
UK Take Over Panel, e.g. there is no oil price MAC risk as UK take
over Panel will not allow any bidder to walk away because of macro
factors like oil pricing


RDSB share price collapsed almost 10% since deal was announced,
however we believe this move might be exaggerated given:

a) EPS accretion: although deal is about 7-12% dilutive before
any synergies, the transaction is mildly 0-2% accretive to Shell’s EPS
in 2017E and 5-8% accretive from 2018E (based on Shell’s oil price
assumptions of 2016 $67/bbl; 2017 $75/bbl & 2018 $90/bbl).

b) Potential multiple expansion: Although one of the bear
arguments was that RDSB lacks production growth (driving RDSB below
peers multiples), BG provides much-needed growth in upstream – which
could easily translate in higher multiples for RDSB: BG’s 2020 output
is expected to be more than 50% higher than 2014 at over 900kboed
compared to a growth profile for Shell which is currently the weakest
among the supermajors over the period 2014-18e:

c) Wrongly perceived loss of dividend (yield): Although some
investors might point to potential loss of dividend yield for RDSB
(after acquiring BG, as RDSB 2015e net leverage marginally increases
from 0.6x to 1.2x), RDSB announced concurrent with the deal
announcement that its intention remains to pay dividends of USD 1.88
in 2015 and at least that amount in 2016 – thereafter the FCF
generation of pro-forma company should further manage to maintain its
dividend (as by 2017 RDSB net leverage should flip back to below
0.7x), allowing that RDSB should remain to be seen as attractive
dividend yield story – and justifying RDSB shares trading around GBP
22 based on average dividend yield of the global oil majors:


Although we believe the chance of a counter in the near term is very
small, there are still number of arguments why it is impossible to
completely rule out any potential interloper risk – especially as deal
is structured as long dated 10-15 months UK Scheme where there is some
inherent value that the chance of an interloper might increase should
oil pricing materially improve before the end of the deal:

1) Absence of termination fee to be payable by BG when competing
offer would materialize (only reverse termination fee payable by Shell
to BG in certain circumstances)

2) BG wasn’t shopped – Shell called BG Chairman on 15-Mar-15
(only 3 weeks ago) with take over offer

3) Recurring rumors and reports that BG would be a target for Exxon and BP:

– 13-Feb-2015: XOM Falling oil prices may dispose Exxon Mobil
to make big purchase – WSJ
In an article based almost entirely on speculation by analysts and
researchers, the WSJ observes that the company has a gigantic pile of
treasury shares and the ability to borrow money very cheaply. The WSJ
reports that analysts are mooting BP (BP.LN), Anadarko Petroleum
(APC), and BG (BG.LN) as targets; Exxon declines to comment.

– 22-Jan-2015: Independent: Exxon Mobil (XOM) or Petrobas
(PETR4.BZ) may offer a £12/sh break-up bid for BG Group (BG.LN). US
funds may buy a stake in Allied Minds (ALM.LN).

– 14-Jan-2015: Telegraph: BG Group (BG.LN) is close to
selling a major asset.

– 16-Dec-2014: FT says BG Group and Anadarko Petroleum widely
seen among potential M&A targets
The FT notes that the crude price slump of the 1990s was responsible
for a wave of giant mergers, and comments that that a similar (yet
less dramatic) reconfiguration of the industry can be expected If the
latest bout of weakness in oil lasts for any significant time; the
article mentions companies including BG Group and Anadarko Petroleum
are widely seen as potential targets, as are those that have activist
investors, including Hess (HES) and Apache (APA)
The article also mentions that in the US shale oil industry, where
growth has been fuelled by borrowing, Pearce Hammond of Simmons & Co,
the investment bank, says “companies that have good assets but that
don’t have good balance sheets” will likely fall to acquisitions

– 08-Dec-2014: XOM WSJ’s Heard on the Street column says
Exxon Mobil may buy something, but not today.
The column says that BG Group (BG.LN) and the E&P sector are
attractively priced, but Exxon needs valuations to sink further before
it’s likely to try to go through with a purchase; the column says that
if oil prices continue to fall over the next 12 months, a deal may
eventually materialize.

– 03-Dec-2014: Daily Mail: ExxonMobil (XOM) may bid £47.7B,
or 1,400/sh, for BG (BG.LN). BP (BP.LN) and Royal Dutch Shell
(RDSB.LN) may merge.
The Times: ExxonMobil may be willing to pay 1,500p/sh for BG.
Telegraph: ExxonMobil and Chevron (CVX) may consider break-up of BG.

– 13-Jun-2014: Financial Times: Continued speculation that BG
(BG.LN) may announce significant asset sales or attract bid interest.

– 29-Apr-14: Financial Times: BG considered a bid target for
ExxonMobil following CEO resignation

– 29-Jan-14: Financial Times: BG considered vulnerable to
PetroChina and other predators.

– 29-May-13: Daily Expres: BG rumoured to be in line for GBP
25 per share take over or break up with bids could come from Shell,
Petrobras, Reliance or EXXONMobil.

4) Number of arguments why XOM as most likely bidder would have
an interest in an asset like BG:

a. XOM IR told us that they would not shy away at all from large
scale M&A at the moment.

b. XOM operates with one of lowest capex requirements, and given
high FCF, XOM needs to do large scale transaction every 5-8 years to
optmizie their balance sheet.

c. EXXON has equal large exposure to BG’s main countries
Australia (ExxonMobil has invested around $19 billion in Australia)
and Brazil

d. acquisition by XOM would be less dilutive for XOM than for
RDSB (about 3-7% dilutive for XOM vs 8-13% dilutive for RDSB before

e. XOM about twice the size of Shell, with no balance sheet
issues to make counter

f. BG would more equally balance exposure to XOM between
Europe/Americas and rest of world: currently Europe/Americas represent
65-70% of XOM total revenues – acquisition of BG would shift that
balance closer to 50/50

g. Potential for uplift from Australia: Australia is the least
profitable in Asia/Africa with $7.92 profit/boe in 2013 due to low
pricing and high production costs, however largely expected that
Australia will become significantly more profitable once the two LNG
projects under construction are completed.

… although we also wanted to highlight that there are some
arguments why XOM would not be fully interested in BG:

a. XOM main Australian LNG assets (Gorgon LNG) is in Northwest
Australia which is at other side of Australia where BG’s LNG assets in
southern Queensland (east coast).

b. Recent M&A and investments from XOM have focused more on
Middle East (28% in 2013 versus 5% in 2002) as well as US gas (14% in
2013 versus 5% in 2008) rather than Australia or Brazil.

c. In 2013 XOM did not participate in the Libra auction which
offered significant Brazilian pre salt resource, which would have
shown XOM’s appetite for large scale assets in Brazil – Libra reserves
were sold to a consortium led by Petrobras, France’s Total,
Anglo-Dutch Shell and China’s state-owned CNOOC and CNPC.

d. XOM prefers an owner/operator model while BG is working with
Petrobras as operator of its Brazilian assets


I- Offer comes less than 12 months after BG’s CEO left in late
April 2014, Brazil macro-economic turmoil and crude pricing weakness:

o When comparing the offer terms, the offer pricing is largely in
line with historical trading levels:


a. Brazil is finally expected to almost triple production in
next 5 years from 144 kbd in 2015 to 557 kbd in 2020 & in Australia,
where its huge USD 10bn investment in its LNG infrastructure is
finally generating positive CF for the first time since 2010)

b. BG is currently at an inflection point and expected to
generate one of the highest ROE in next couple of years:

c. BG has one of highest exposures to Brazil, where oil majors
can still grow significantly at much lower than average costs: