University of Wales Trinity Saint David

Executive Summary

The report aims to determine the success of the merger and its impact on the shareholders. The chosen company for preparing this report is Royal Dutch Shell-BG Group that has been merged in the year 2015. The discussion analysis is based on the success or the relative failures of mergers in terms to achieve the company’s goal. At the end of the discussion, a suitable recommendation has been given for a successful business combination and to increase the probability of future success of the combined entity.

Introduction

Over the last three decades, it has seen that companies are choosing merger and acquisition as one of the growth strategies so that to increase the wealth of the shareholders. The merger is able to create synergy when a combined or merged company results in more value than the value of two individual companies (Ghosh and Ghosh 2014). The report aims to determine the success of the combined entity that is Royal Dutch Shell – British Gas Group and its impact on the shareholders. The discussion dealt with a detailed underlying theory behind the merger and acquisition and analyses the selected merger in terms of its success or failure to the goal that was set by the company. At last, a recommendation is given for a successful business combination. Before the merger, BG Group stands individually as a multinational oil and gas company. The main working of BG Group was to produce LNG by the process of exploration and extraction. Shell is a global group that is engaged in working as an energy and petrochemicals companies with advanced technology that takes an approach to form a sustainable energy future (Shell.com 2019). Royal Dutch Shell has acquired BG Group on 15 February 2016 for $70 billion. Now, BG Group is a part of Shell and together the companies working is focused on their core expertise in deep water and LNG that is Liquefied Natural Gas (Shell.com 2019).

Discussion

Section 1: Merger and Acquisition (M & A) The combination of two companies refers to mergers and acquisitions (Malik et al 2014). In the case of a merger, the two different companies agree to combined their business so that to increase sales, efficiency and capability. Merger is a corporate strategy that leads to combining two or more companies with a single entity so that to form a separate new entity in order to enhance their financial as well as their operational strength (DePamphilis 2019). It results in A + B = C. In this case, the separate entities combine their forces to form a strong new entity. It is agreed by both the companies to share their strengths and fill the gap areas in which they are lacking.
However, when a big company takes over the majority stake in the small or less powerful company is termed as an acquisition. It generally takes place when one company purchases another company (Green 2017). The acquiring company gets full control over the acquired company (Zaheer, Castaner and Souder 2013). It results in A + B = A. Therefore, in the case of acquisition, a new entity does not form but the acquiring company takes over entire decisions of the operational management of acquiring company. A company needs a huge amount of cash for acquisition. Nevertheless, the acquirer’s power is absolute. Royal Dutch Shell declared in April 2015 that they are agreed to purchase the BG Group and completed the acquisition in 2016 subject to regulatory and shareholder approval (Urmal 2017). This acquisition is considered the biggest in its specific sector after the Exxon Mobil merger in 1988 (Kumar 2019). In terms of market capitalization, this merger has resulted as the second-largest as in non-state oil company.

Section 2: Underlying theory behind Merger & Acquisition

Companies can have several motives or purpose for doing a merger or acquisition with some other company. The basic motive is growth. Other motives can be the creation of synergy (AB > A + B) and diversification. It is possible with merger and acquisition to reduce competition, and it could result in higher prices for the consumers. The companies at the time of merger and acquisition have the objective to experience economic gains (Dutordoir, Roosenboom and Vasconcelos 2014). The economies of scale can lead to the economic gains to the company. Synergy covers a wide area that is having different sources for its origin. The sources of different types of synergy are discussed below.

Cost Synergy


Economies of Scale Economies of scale occur when a large entity with its increased output is able to decrease its average costs. In case of merger and acquisition, economies of scale is achieved by company when there is a reduction in costs with an increase in the scale of production at a specific time. As the cost of production includes a fixed component that does not vary with the volume of production like rents and administrative costs (Rahman and Lambkin 2015). The cost per unit includes both fixed and variable costs, at the time when fixed costs spread over a large volume of goods or services then it leads to scale economies (Yoo, Lee and Heo 2013). In the technique of merger or acquisition, involvement of two companies enhances economies of scale.

Financial Synergy


Elimination of inefficiencies Merger and acquisition helps the companies especially that is being acquired in eliminating their inefficiencies. The acquired company has the possibility of badly managed its performance that resulted in lowering their profits and decline in the organisational value. The acquisition comes as an opportunity to such companies so that the acquiring company can fill the gaps of the other company and adds value to their working (Rozen-Bakher 2018). The improvement can be in several areas like finance, marketing and production. The merger and acquisition helps both the companies to get combined and work as a single team to increase their profitability by reducing or eliminating the inefficiency existing amongst them.

Surplus cash The companies with good cash position and better market availability look for an opportunity of acquisition. As the company looks acquisition as a more appropriate application of these funds so, it was found to be a more suitable way for merger or acquisition (Reddy and Xie 2017). Further, surplus cash can be taken as a cure with an increasing dividend. However, the adoption of such may be avoided due to the reason for taxation or dividend constancy. Financial benefits The decision of merger and acquisition have financial benefits as the acquiring company acquires advanced technology as well as specific knowledge about the acquired company’s working or product. This reduces the additional cost of the acquiring company for efficient working of the company. Through merger and acquisition, company reduces its operating cash flow by combining two or more entities (Piesse et al 2013). Moreover, the stability in the cash flow can attract more creditors that result in cheaper financing. Thus, the company has financial benefits through reducing operating cash flow and increasing reasonable financing.

Diversification

In the case of merger or acquisition, the company through diversification reduces their risks and improve revenue. On the combination of two different sectors, one of the benefits that the company's shares are their knowledge (Arikan and Stulz 2016). The diversification results in sharing and applicability of knowledge of two different companies in a single organisation. Further, they have an opportunity to expand themselves in other areas of working along with their current working specialty.

Revenue Synergy

Increased power in the market The companies may take the decision of merger or acquisition to increase its power in the market so that they will be eligible to work out some control over the price of the specific product in the market. In the case of a horizontal merger, the firm is benefited by obtaining monopoly (Matsushima, Sato and Yamamoto 2013). The increased power of monopoly results in increasing profitability of the firm through raising the price due to having less or no alternatives for the customers. Combining Complementary resources Merger and acquisition supports the companies through share their resources with one another after their combination. The company can control the assets and resources can either be through the purchase of those assets or can through taking control over the shareholding. The combination of two companies makes available the firm’s resources as well as the knowledge for the single firm formed after the combination of two companies (Grimpe and Hussinger 2014). The combination of two companies also combines their strength and thus declaring into a synergetic result.

Others

Speed of growth The speed of growth through acquisition is much faster than organic growth. Organic growth is generated within the firm through internal operations. Where a small company wants to achieve a steady growth in their business and they have not enough money to do so but have resources, in such case the small company can get acquired in to a big one so that it get financial support and a rapid growth. The acquisition is a much quicker way to enter in to a new market and to adopt a new product or service. This may be a faster way through which a firm can obtain its presence in a new and emerging market (Phillips and Zhdanov 2013). Further, the company can eliminate their competitors from the market through merger or acquisition that supports their growth. Regulatory framework The public companies takeover in the UK is governed through the Takeover Code. This involves the acquisition of control of a target company either through a contractual offer to the shareholders or through the proper approval of the court (Acheampong, Ashong and Svanikier 2016). The regulatory or governmental consent is needed for the clearance of the merger. The regulations of the merger and acquisition vary from country to country. However, the primary focus is about controlling the directors. The factors that include in these regulations is – To treat all shareholders equally. The shareholders have to provide with all the relevant information to make an informed decision. The board must take any decision with the approval of the shareholders. The information shared to the shareholders must be prepared with care and accuracy. Forecasting of profits must be based on accounting policies.

Shareholders wealth

Merger and acquisition brings volatility in the stock price or increase in the market’s share price by combining with the other company (Ng and Donker 2013). That results in adding value to the shareholder’s wealth. Further, the acquisition technique used by the company for their growth eliminates the competition of two firms. Through this, the company can maximize its production and set a suitable price to earning expected profits. This leads to increase shareholder’s satisfaction and loyalty by increasing their value of wealth. Section 3: Analysis on the selected merger- Royal Dutch Shell - BG Group As Shell has declared their combination with British Gas Group in 2015 and the merger took place as a vertically integrated operation in the year 2016 (Barcelona 2017). The merger between both the groups resulted in the absorption of BG group in to the Shell. Purpose of merger Shell basic purpose of the business is to involve both crude oil and natural gas, which leads to expansion of their business and their presence in the other market. The purpose of Shell is to give power to their process and progress together so that to fulfil the demand for energy as well as oil and gas to the global population with cleaner energy solutions (Shell.com 2019). The merger allows the Shell group to create its presence and position in Australia as well as Brazil. This merger allows the company in the creation of revenue synergy by creating its position in the market and by combining their complementary resources.

Strategy and Financial Objectives

The Shell group seeks to improve its operating performance and maximize their sustainable cash flow. The Shell believes in BG group on their strategic priorities with deep water and the exploration of liquefied natural gas. The strategy of the group is the growth of the business and maximization of their shareholder’s wealth. However, Shell has also compensated the shareholders of the BG group by giving cash and stock per share they held. The combined knowledge of Royal Dutch shell with BG group have an opportunity to generate cash flow of $15-$20 billion with two strategic growth of the business that is deep water and integrated gas. The combined group’s financial objective is to generate cash flow that is to be used in reducing debt, to pay dividends, to do capital investments and buyback shares. The merger resulting in creating financial synergy for the groups by generating surplus cash, using combined knowledge as well as technology helps in eliminating inefficiencies and achieve financial benefit through reducing operating cash flow. Business and Financial Risk The merger of these groups generally have three combined risks: There is a risk of integration during the merger. As the avoidance of distraction of management could have created a problem. If the integration has not correctly carried out, then the acquisition may fail. The volatility price of oil over the last few years is a major financial risk in this merger. Due to the amount spent in the acquisition, the company can no longer afford any price variation that may result in their loss. There is a risk of going price against the expected one. There is a risk of negative influence in the financial market due to the disclosure of information. Shell has ensured to maintain transparency throughout its merger process so that to avoid any negative or bad effect. Value of Merger Shell-BG has to add profit to the shareholders in order to add value to the merger. Shell has expected to reach $2.5 billion as pre-tax synergy by compromising $1 billion from operating cost savings and $1.5 billion in a decrease in expenditure. The combined group will have net hydrocarbon reserves of 16.7 billion barrels of oil equivalent. After the adjustment of the post-tax operating cash flow, it will lead to the annual cash flow of $1.2 billion for the existing shareholders of Shell. If this cash flow will remain with time, then it has the possibility for the value addition of approx. $8.75 billion for the shareholders at the time of the deal. The merger can occur economies of scale, as Shell believes that the company would save the cost of $3.5 billion annually and leads to upgrade the production of oil and gas by 20%. The cost reduction will reduce the procurement and supplier costs along with the savings on shipping and logistics. Financing the Merger Shell plans to finance the merger by considering cash payable to the BG shareholders through existing cash resources and debt from a third party. Shell has entered to get bank facility with Bank of America as mandated lead arranger, and Lynch International limited as facility agent for the connection to financing the cash that is payable to the BGs shareholders. Bank of America Merrill Lynch is satisfied with Shell's resources for full cash finance. On the other hand, the fluctuation of the price of the oil against the expectation may decrease in the credit rating that leads to an increase in the debt interest (Andrews and Varrasi 2015).

National and Foreign Economies

By employing the above 92,000 skilled employees by the merger, Shell is able to contribute towards the national and foreign economy by increasing the circulation of money in the market (Kaittibie, Jaidah and HAq 2016). Addition to this, it has created diversification by expanding knowledge of both the groups for delivering innovative products and an efficient process of recovery (Bena and Li 2014).

Recommendations

The merger of Royal Dutch Shell-BG Group is in a good position. However, there are certain limitations in some areas after the merger in which they can focus to improve for a successful merger that is mentioned below. As they have no control over the alternative fuel companies so, a perfect strategy has to implement so that to overcome with any near issue. It is very competitive as it has highly externally dependent on oil and its price. Therefore, they always have to maintain a good relation and communication. The merged group cannot afford to ignore any government and environmental laws as any misconduct can result in a huge loss with some strict action of the government. Therefore, the company must follow the laws. The group should form a plan to cope up with the depletion of oil reserves. For a successful merger and acquisition, the company must evaluate its liquidity and financial capability during the merger. They must ensure the information to be passed securely and efficiently. A team of skilled employees can create a difference in the growth and success of the merger and acquisition.

Conclusion

The acquisition reflects a good opportunity to Royal Dutch Shell to purchase a company who is facing a reduction in the market value and knows that in the near future from the earlier investments made by them, they are going to assimilate the profits. Royal Dutch Shell-BG group is able to achieve different synergies through their merger and will have the potential of value creation. Further, the acquisition is beneficial to the shareholders of BG Group by achieving a huge and immediate return.
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