Dan Loeb is oversimplifying Shell's long game

NEW YORK, Oct 27 (Reuters Breakingviews) - Dan Loeb is gunning for Royal Dutch Shell (RDSa.L), opens new tab. The activist investor’s fund, Third Point, has taken a stake in the $190 billion European oil giant and wants it to separate into two businesses. That makes some sense, but it may also complicate an increasing imperative to decarbonize.

Europe's oil majors have been ahead of U.S. peers in going green. Their investors are more bothered about climate change, but in Shell’s case a Dutch court also recently ordered it to slash emissions by 45% by 2030. That prompted a sale of its U.S. Permian Basin wells to ConocoPhillips (COP.N), opens new tab for $9.5 billion.

Loeb argues that Shell’s conglomeration of energy assets combines ill-fitting and diverging goals. He wants to separate legacy fossil-fuel assets and chemicals from “transition” gas stations and liquefied natural gas. The latter would be the holding division for the future renewable-energy businesses.

Financially, his argument stacks up. The transition business is much less capital intensive than drilling for fossil fuels and has a lower cost of capital. And given Shell trades on a relatively discounted 4 times next year’s EBITDA, separating it out could create value. Assume the transition business generates $25 billion in EBITDA in 2022, as Third Point estimates, and it alone would be worth at least $250 billion, using Alimentation Couche-Tard (ATDb.TO), opens new tab and Cheniere Energy (LNG.A), opens new tab multiples for the gas station and LNG bits respectively. That’s roughly Shell’s enterprise value now.

Even if the remaining $35 billion of EBITDA in Shell’s legacy oil business traded at a lower multiple than at present, a split could still generate value. Shell would have a stronger stock currency to buy up renewable businesses or issue equity to build its own. And it would have a shareholder base that is more aligned with that goal.

The catch is that green investors might twig that Shell’s “transition” business was really a massive gas player with a small renewables business tacked on. As such they might assign it a lower multiple. Throw in separation costs and the value proposition looks less enticing.

True, oil prices above $80 a barrel mean a cash-gushing stand-alone legacy business could be popular. But that cuts both ways. If it all stayed together under one parent, Shell boss Ben van Beurden would have more cash to make the transition happen before fortunes for either business turned. The fact that he has been slower than rivals like BP (BP.L), opens new tab to do so doesn’t undermine the point.

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CONTEXT NEWS

- Activist investor Dan Loeb’s Third Point has built a stake in Royal Dutch Shell and is urging the company to break up, according to a Third Point letter to investors dated Oct. 27.

- In the letter, the fund manager said Shell “has too many competing stakeholders pushing it in too many different directions, resulting in an incoherent, conflicting set of strategies attempting to appease multiple interests but satisfying none.”

- Reuters reported that Third Point's stake was worth $750 million, against Shell’s market capitalization of almost $190 billion.

- Shell said in a statement that it regularly reviewed and evaluated its strategy with a focus on generating shareholder value.

- “As part of this ongoing process, Shell welcomes open dialogue with all shareholders, including Third Point,” it said. “Shell’s investor relations team has had preliminary conversations with Third Point and we will engage with them, as we do with all of our shareholders."

- Shell also said that it had set out its "Powering Progress" strategy earlier in the year and that its energy transition strategy had received 89% support from shareholders at an annual general meeting in May.

- Earlier this year, activist investment fund Engine No. 1 pushed Exxon Mobil to add directors to its board who had a more specific focus on climate-related issues.