Halliburton to buy Baker Hughes for $35B

Halliburton's proposed acquisition of Baker Hughes — uniting the second- and third-largest U.S. providers of oil field services — could signal increased consolidation in the energy sector.

Falling oil prices helped fuel Halliburton's $34.6 billion stock-and-cash deal Monday for its smaller competitor. Together, they'd form a powerful rival to the No. 1 player in their business, Schlumberger.

"It makes tremendous strategic sense," said Chris Pultz of hedge fund management firm Kellner Capital. "It's the right time because you have the re-evaluation of the sector with oil prices coming down."

Consolidation will likely continue not only among smaller oil services providers, but also the energy industry as a whole, he says.

With the average energy stock in the Standard & Poor's 500 down 5.6% this year, analysts think that the sector is ripe for a rally — Halliburton is among 10 stocks with an average expected 18-month upside of nearly 41%.

Low oil prices could spur more mergers in the sector, says Stewart Glickman, energy equity analyst at financial research firm S&P Capital IQ. "The concerns that these guys are arguably seeing, I think others could be seeing as well," he said.

Two possible oil services takeover targets: Weatherford International(WFT) and Superior Energy Services (SPN), both of which Glickman upgraded today to "Buy" status.

The Halliburton-Baker Hughes deal is the largest merger deal in the oil industry since 2010 when Schlumberger (SLB) bought drilling technology leader Smith International for more than $11 billion.

This deal is more than three times that size because both Halliburton and Baker "have a bigger footprint than Smith did," Glickman said. "It's a pretty landmark deal."

Halliburton and Baker Hughes have a combined market value of more than $70 billion, compared with Schlumberger at about $124 billion.

Among all mergers and acquisitions so far this year, the Halliburton-Baker Hughes deal is the eighth largest, according to Thomson Reuters. Oil and gas M&A activity has hit $368.7 billion so far this year, nearly double the same period last year — and the highest year-to-date level in the sector since the 1970s.

Baker Hughes (BHI) surged $5.34, or 8.9%, to $65.23 Monday. Halliburton (HAL) ended the day down $5.85, or 10.6%, to $49.23.

The deal comes amid a sharp dive in oil prices, with a barrel of West Texas Intermediate crude tumbling recently to its lowest level in more than three years, creating both havoc and opportunity for companies whose livelihoods are tied to the price of oil. Prices settled down 18 cents to $75.64 a barrel Monday.

Wall Street expects the big drop in oil prices, which has also had a negative effect on stock prices of companies in the energy sector, to prompt similar deals as companies look to solidify their businesses in an increasingly difficult business environment.

Baker Hughes had some shale oil production and exploration expertise that Halliburton saw as valuable, said Phil Adams of corporate bond research firm Gimme Credit. Since falling oil prices had driven down oil industry shares, the Baker Hughes acquisition became a better deal.

"When your competitor or a company that you think would add a complementary service to your business line gets cheap in the equity market because the stocks are down, it's a good time to use your financial strength to complement your portfolio," he said. "That's what makes the timing right."

The oil-patch marriage, which was approved unanimously by both boards, comes after weeks of discussions, which were reportedly chilly at times, according to media reports. Halliburton made its first offer to Baker Hughes on Oct. 11.

Dave Lesar, chairman and CEO of Halliburton, said the deal will result in annual cost savings of nearly $2 billion. Savings will come from operational improvements, personnel reorganization, real estate, research and development, corporate costs and other efficiencies.

Lesar said the acquisition will improve Halliburton's cash flow by the end of the first year after closing and earnings per share by the end of the second year.

The combined company will "create a bellwether global oil field services company," Lesar said in a conference call with analysts. "There is no doubt about the strategic merits of this combination. It is a compelling transaction with many strategic and financial benefits."

The Halliburton CEO said the transaction, which is expected to close in the second half of 2015, combines two highly complementary suites of products and services into a comprehensive offering to oil and natural gas customers. The companies together had 2013 revenues of $51.8 billion, more than 136,000 employees and operations in more than 80 countries around the world.

Under the terms of the agreement, stockholders of Baker Hughes will receive, for each Baker Hughes share, 1.12 Halliburton shares plus $19 in cash.

The deal values each Baker Hughes share at $78.62.

The merger is subject to regulatory approvals and could face antitrust questions as the two companies are the second- and third-biggest oil services companies in the U.S. To get the deal done, Halliburton has "agreed to divest businesses that generate up to $7.5 billion in revenues, if required by regulators," although Halliburton believes that the divestitures required will be significantly less.

Should the acquisition fail to get antitrust approvals, Halliburton has agreed to pay a fee of $3.5 billion to Baker Hughes.

Analysts differed on Halliburton's long-term view of the industry, the subtext for the deal. "I would characterize this as a defensive move in case oil prices weaken considerably further from where they are," Glickman said.

In contrast, Brian Gibbons, a senior analyst with research firm CreditSights, expects that Halliburton foresees "a short-lived price dip" and a chance to "take on industry-leader Schlumberger over the long term," he said in a note Monday.

That means that the timing of the deal suggests, he said, "that Halliburton has a robust view on oil market conditions moving forward and that the deal is being driven opportunistically, not defensively."