Could an acquisition restore Shell?

Jan 10, 2005 01:00 AM

The oil patch is abuzz over the possibility of deep-pocketed Chinese energy companies striking big takeover deals in the sector. But some industry watchers are keeping an eye on another possible suitor: Shell.
Conventional wisdom has it that today's high oil prices are damping the appetite of Western oil majors for large acquisitions, because pricey oil makes most targets look expensive. But after an executive-suite housecleaning and amid a corporate overhaul in the wake of an accounting debacle last year, Shell still hasn't convinced many investors and analysts that it has turned a new page. A big, strategically sensible deal may go a long way to restoring confidence in the company, some industry watchers are starting to say.

A series of downgrades of the company's reserves of oil and natural gas reduced the Anglo-Dutch giant's energy holdings by about a quarter, making it a much smaller company than just a year ago by one important investor measure. Shell executives also have acknowledged that oil production is likely to fall this year, making for another embarrassing comparison with its two closest rivals, ExxonMobil and BP.
Shell's share price performance lagged behind Exxon, BP and many other smaller rivals most of last year.
"Royal Dutch needs to do a deal. Their reserve profile and production profile are not competitive," says Fred Leuffer, an oil-equities analyst at Bear Stearns in New York. He holds an "underperform" rating on Shell's two parent companies. Shell wasn't an investment-banking client of Bear Stearns in the past 12 months, the bank said.

One possible fit: Unocal. The El Segundo, California, company saw its share price soar on reports that China National Offshore Oil, a state-controlled entity known as CNOOC, was considering a bid. With a market capitalization of about $ 12 bn, it has untapped gas reserves in Asia, already a strong market for Shell.
Shell CEO Jeroen van der Veer has said he won't overpay for assets. But unlike many of his peers, he also has pointed to acquisitions as a way to replenish Shell's reserves and production.

Most analysts and bankers don't see Mr van der Veer moving until the completion of a complicated restructuring under way that will unify Shell's two holding companies and streamline a century-old corporate structure. Final investor and regulatory approval isn't expected until June.
But Mr van der Veer -- who took over in March after his predecessor was ousted amid the reserves debacle -- has surprised markets before. He unveiled Shell's corporate restructuring ahead of schedule, and he settled a Securities and Exchange Commission investigation into the reserves scandal much more quickly than expected.

And while oil prices are way above the levels of recent years, they might not be too high to block a deal. In a September strategy session, Shell executives said oil prices had shifted "structurally higher," echoing forecasts from a growing number of industry analysts and executives and suggesting that the oil world is coming to terms with higher prices.
Recent signals by OPEC suggest that the organization, a group of some of the world's biggest producers, will try to keep the floor for US benchmark crude at nearly $ 40 a barrel for the foreseeable future.

Even before its reserves problem, Shell -- along with its peers -- was struggling to replace the oil and gas it uses each year. Reserves, a crucial investor metric, are the estimate of oil or natural gas that a company expects to some day pump out of the ground.
"I think you'll see a hell of a lot more merger-and-acquisition activity" in the oil patch if prices continue to creep toward $ 35 a barrel, says Neal Anderson, a Houston-based executive at energy consulting firm Wood Mackenzie. He thinks so-called super majors such as Shell might go after smaller peers focused on exploring and producing oil.

Beyond Unocal, the list of potential targets includes BG Group, the British natural-gas giant. BG for years has been rumoured as a possible acquisition target for Shell, which recently has played up its focus on natural-gas projects. BG's market capitalization was about $ 23 bn, just a fraction of Shell's market cap, which approaches $ 200 bn.
A host of other second-tier, exploration and production-heavy companies in the US suddenly are under the spotlight after word of CNOOC’s interest in Unocal. These include Occidental Petroleum of Los Angeles and Devon Energy, based in Oklahoma City.

Shell faces obstacles, most notably its lack of credibility in the wake of the reserves scandal and other recent missteps. Executives still are smarting from their decision to wait out the industry-changing consolidation of the late 1990s.
Compared with its peers, Shell's stock price was undervalued most of last year based on its estimated earnings, according to many analysts. After Shell's last earnings report in October, analysts pegged Shell's 2004 price/earnings ratio at about 11, compared with 14 for Exxon and 13 for BP. Shell reports year-end results early February.

That helped spark talk that Shell might be a target itself, though its size and globe-spanning girth could make it difficult for anyone else to swallow.
Last year, Fadel Gheit, an Oppenheimer analyst in New York, floated the benefits of a BP-Shell merger at the height of Shell's troubles, though a tie-up appears almost impossible because of antitrust and regulatory hurdles. Speculation also surfaced that French oil giant Total was a potential Shell suitor before Total denied those rumours.

Source: The Wall Street Journal
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