Rumors started surfacing late Tuesday afternoon via a Wall Street Journal report that Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) was in talks to acquire BG Group (LSE: BG) (NASDAQOTH: BRGYY). Those rumors proved to be true, as BG Group confirmed it was in advanced talks to sell itself to Shell.
By this morning, a deal was in hand, as Shell offered a stunning 52% premium to acquire BG Group. The deal, in all likelihood, is just the first domino to fall, as a wave of merger activity looks to be on the horizon.
Big oil gets bigger
Shell is paying a hefty price, as the 52% premium puts a price tag of $70 billion on BG Group. That's far more than analysts had expected yesterday when many saw a potential deal settling in the $50-billion range, as Shell was thought to be only offering a meager premium due to weak oil prices. Needless to say, this premium sets the bar high for future deals. However, Shell saw a chance to make a real needle-moving deal, and it pounced on that chance.
In buying BG Group, Shell will boost its proven oil-and-gas reserves by 25%, while also boosting production by 20%. Further, the company will gain BG's promising prospects that include LNG in Australia, and Brazil deepwater assets. In addition to that, the deal will provide the combined company with $2.5 billion per year in pre-tax synergies, which is a big deal considering where commodity prices are these days.
To top things off, if Shell's acquisition of BG Group goes through, it's poised to become the biggest of big oil by 2018. This is after the combined company's average daily production is expected to hit 4.2 million barrels of oil equivalent per day, putting it on pace to exceed the projected 2018 production of current kingpin ExxonMobil (NYSE:XOM). Shell might have more work to do as its big oil peers aren't likely going to sit still and simply let it take top billing.
More to come?
Shell more than likely set in motion what could become the next big consolidation wave in the energy sector. Most of the big oil giants we know today were birthed in the late 1990s after oil prices collapsed. From 1998 to 2001, the industry paired up, as BP (NYSE:BP) bought both Amoco and ARCO for $48.2 billion and $27 billion, respectively, Exxon bought Mobil for $80 billion, and Chevron (NYSE:CVX) bought Texaco for $39.5 billion.
At that time, oil companies wanted to cut costs, as low oil prices ate into cash flow and merger synergies were the best way to move forward. The $2.5 billion per year Shell will save by acquiring BG Group is as good an incentive to merge as any.
In fact, analysts are already suggesting that Shell's offer might not be the only one BG Group gets. Some analysts are suggesting that Exxon might actually look to outbid Shell for BG Group, as it has the financial wherewithal to easily top any rival in a bidding war. There are so many other compelling opportunities, though, that Exxon and other big oil giants don't have to outbid each other for a needle-moving deal.
Many analysts point out that U.S. independents like Hess (NYSE:HES) or Apache (NASDAQ:APA) could make strong targets for big oil. Not only do these companies have strong unconventional growth prospects, but these two in particular have activist investors who have long been pushing for change. The easiest way for these activists to create value would be to push for a lucrative sale.
Meanwhile, other independents could be takeout targets due to weaker balance sheets, which are holding back growth and value creation. Given the weakness in the oil market right now, any oil company could be available at the right price.
The energy industry is entering a very interesting period. Shell's bid for BG Group could be the first domino to fall as it sets the price standard that all others in the market will now look to as a base. The high premium could be what breaks an impasse between prospective buyers and sellers, as it suggests that oil-and-gas assets are worth more to a big oil company than the market currently values them by staying independent.