Shell’s Exit from Pakistan: What Price could it get?

 

The rabbit is out of the hat: Shell Plc (who I will refer to as Shell global) is selling its stake in Shell Pakistan Limited. Shell global’s exit from Pakistan has been the talk of the town. Much has been said about it. Some have said that the exit is bad for Pakistan’s image – shows foreign investors that business confidence is low. Others have said the exit is good for Pakistan as it might prevent outflow of dollars through profit repatriation. Although that would only be the case if a local company purchases Shell global’s stake.

But what about the elephant in the room: Shell Pakistan’s valuation? And why does it matter for minority shareholders?

As per SECP law, in the event of a substantial acquisition, the acquiring company has to make a public offer as well. In other words, it must also offer to purchase shares from minority or free-float shareholders. The minimum offer price for this is the highest among:

(a) weighted average price of stock purchase agreement (SPA)

(b) highest price paid by acquirer for shares of target company in the past six months prior to public announcement of offer

(c) weighted average share price of target company in the past six months prior to announcement of public offer

(d) weighted average share price of target company in the four weeks prior to public announcement of intention

(e) book value per share

Now, the book value per share is Rs 46 while weighted average share prices (over any period) are much higher. So, option (e) can be cancelled out. Meanwhile, no potential buyer has bought shares of Shell Pakistan so option (b) can also be ticked off. This leaves three options.

Among these, option (a) is likely to be the minimum offer price since the market value of Shell Pakistan shares are still far below a potential acquiring price. So, this leads us onto the big question: what value can we put on Shell Pakistan?

In the event of an acquisition, the acquirer can value the target company in different ways. Firstly, it can choose to pay attention to book value. Book value is simply the accounting method of valuing equity. However, it can be highly outdated since assets purchased are valued at cost minus depreciation. This is very much the case for Shell Pakistan as well since Shell’s most valuable assets (land, an appreciating asset) were purchased decades ago and have been valued at cost as opposed to market value.

Secondly, the acquirer can choose discounted cash flows (DCF) as a method of valuation. DCF is generally a good valuation tool, but it relies heavily on a good prediction of future cash flows. In the case of oil marketing companies in general, future cash flows are uncertain due to the transition to renewables (hard to estimate terminal value). In the Pakistani context, margins are fixed by the regulator making it even tougher to predict FCFs. You can take assumptions to arrive at a DCF value, but it could be wildly optimistic or pessimistic depending on the assumptions taken. Thus, it would be a poor measure of value (easily manipulated).

There are other methods as well such as multiples valuation (revenue multiples as an example) or relative valuation, but they’re generally not used to value a large, long-term investment like Shell Pakistan’s business. This leaves us with the valuation technique I’ve used: net asset value.

Net asset value is calculated by taking the market value of assets and netting off liabilities. It is simply taking book values and updating them with market values to arrive at an estimate of the company’s equity. This is the best approach to valuing Shell Pakistan because much of its valuable assets (land) are in prime locations and can be sold or converted into other ventures readily. Also, net asset value is a good valuation indicator since Shell Pakistan used to be wildly profitable in the past. One could argue that with a change of management direction, Shell Pakistan’s assets could be used more profitably (unlocking greater value).

I have calculated a conservative estimate of Shell’s value based on this method here. The major point of contention would be land valuation. The land was valued using Zameen.com’s index tool. Commercial property rates were used if they could be found. If they could not be found, general plot rates were used. If no data was available on a location, values from a neighboring location were used. For instance, no value was available for Keamari industrial/commercial land, hence plot rates from Clifton Block 1 (located next to Keamari) were used.

It must be highlighted that the land valuation could be inaccurate. For example, Shell’s Marine Drive petrol pump land was valued at PKR 1.4 billion. But when I called a real estate broker in Karachi, he gave a rough estimate of 175 crore (1.75 bn) rupees for the same property. Since my aim was to be conservative in the valuation, I applied a 20% margin of error on the land value. Although, to get a precise estimate of Shell’s land, one would have to make use of property brokers and land appraisers from across Pakistan.

Similarly, I applied a 20% margin of safety or discount on Shell’s net value. This was done to accommodate the fact that Pakistan has a tough business environment currently with huge hurdles in profit repatriation. Meanwhile, global interest rates are high and global liquidity is constrained so a potential acquirer might be willing to pay less for Shell Pakistan.

Based on this valuation, Shell’s price per share would be 177 rupees. This imputes a market capitalization of 37.9 billion rupees ($131.9 million). So, Shell global’s stake in Shell Pakistan would be worth $101.9 million.

However, Shell’s ultimate SPA price might be wildly different. This is because acquisitions are very much about supply-demand. If there are several potential acquirers vying for a piece of Shell Pakistan, then Shell might be valued much higher than this. But the converse could be true too.

For shareholders of Shell Pakistan, it’s a waiting game now. But the good thing is that the wait might not be too long.