Monday, April 11, 2016

Halliburton-Baker Hughes Merger Denied

The mergers and acquisitions line is finally bustling with the news of two large oil services looking to give birth to a larger, more efficient firm that can thrive in a low price environment. Halliburton and Baker Hughes have been in talks of merging for a while now, a deal which could have significant implications for that particular industry.

The deal included an offer by Halliburton to buy out its rival for about $34.6 billion, reports DealBook. The collision course mapped out will help cut costs by almost $2 billion by meshing together the second and third rated operations in the country. By the terms of the deal, Halliburton would "pay 1.12 of its shares and $19 in cash for each Baker Hughes share...valued at about $78.62 a share." In the end, Halliburton would own 64% with Baker Hughes leadership left with a 34% minority. The proposal came as no surprise to investors who had begun to feel tension in the oil services industry as low crude prices significantly reduced demand for new machinery and both firms' ability to compete with Schlumberger, their largest competition. A year and a half later, the merger looks to be in peril with antitrust officials flashing the red lights.

From Yahoo Finance
The reasons behind the deal are clear. Halliburton (HAL) and Baker Hughes (BHI) have failed to keep up with the impressive performance of the gargantuan rival. Schlumberger (SLB) is almost twice their size meaning that a merger would still leave the newly formed corporation at second place in the oil services industry. As far as revenue streams go, the comparison looks a lot favorable for the underdogs. Investors are actually paying less per dollar of revenue in choosing either HAL or BHI versus SLB (1.36 or 1.20 versus 2.62). The major advantage that SLB has over its two competitors is its margins which are over twice as big (0.20 versus 0.11 and 0.08). Because of its ability to keep costs low and operate efficiently, SLB has managed to maintain an earnings per share (EPS) well over $1. HAL and BHI, on the other hand, are operating at losses with the latter recording net income losses of almost $2 billion. For that reason, investors are noticing the potential of incredible earnings growth for SLB come a day with better oil prices. Their ability to run over $2 billion worth of profit bodes well for dividends making them a safe bet for traders amidst uncertainty. 


Even though all three companies have seen their stock sold off since the beginning of the oil glut, SLB has seen the least loss out of the bunch. The chart above shows the securities' performances against the S&P 500 and the respective losses. Both HAL and BHI saw their shares sold off more than 45% of their girth while the top oil services company did better by more than 10%. Investors just preferred the large cap stock even though its price is twice as high. Its two competitors saw an opportunity to compete when their market and books prices dropped significantly. Halliburton, in particular, has been aggressively pursuing the venture offering to divest billions of dollars worth of assets in order to satisfy the antitrust force's desire for a third competitor. 

But despite the apparent rigor of the pursuit, its attempt to pass has been stymied by a lawsuit filed by the Department of Justice under antitrust laws. With the disappearance of a third competitor, the government argues that the oil services industry could experience problems with "collusion," an increased likelihood of "higher prices," and "less overall economic efficiency." With the firms already strapped for cash, fighting this judgment would prove to be an expensive path to take. So yes, investors can look past the deal on to the repercussions. Upon the cancellation, Halliburton will be forced to pay a $3.5 billion break-up fee which will benefit Baker Hughes by adding to their cash reserves. 

So what's that mean for the oil services industry? It seems clear that most of the large-cap firms are currently shopping for cheap assets to add to their repertoire. With oil prices looking to rebound this year, firms like SLB, HAL, and BHI will be searching for ways to capitalize on the new demand for oil and gas machinery. BHI, with an incoming cash bonus of $3.5 billion, will be looking to bolster their financial position whether that's purchasing new assets, buying back stock, or increasing dividends. The rigorous behavior shown by HAL puts them next in line for the proverbial M&A cashier as well. SLB's desire to shop around may be significantly smaller as their focus should be on pushing costs down and driving revenue up to solidify their financial position. An OilPrice.com article suggested that Weatherford International and Franks International could be possible targets for acquisitions. The purchase of either of these two large competitors would be the beginning of a large-scale consolidation in the oil services industry. The longer an environment of depressed oil prices subsists, the more likely and more robust the change will be. Nevertheless, investors should look for some small- or mid-cap oil service firms with high book-to-market-value ratios. These stocks might get boosted by the prospect of purchase when the time comes. At the same time, look for low debt ratios. Companies that are in an ideal debt position will be able to negotiate a better market price for their assets than their debt-filled counterparts. For long-term security, though, SLB is an ideal choice in the oil services industry. HAL and BHI appear to be unable to steal away market share from this behemoth and will struggle to do so unless they can find ways to maximize earnings potential by boosting their gross profit margins.

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