Halliburton - the second largest oilfield services company - will acquire Baker Hughes, the third largest player, creating a services behemoth that could challenge industry leader Schlumberger in a market in which technological capability and geographic presence have been a key theme. The stock and cash deal, which values Baker Hughes’ equity at $34.6 billion, is expected to close during the second half of 2015, subject to the approval of shareholders from both companies and regulators. Although the market reaction to the deal was decidedly mixed, we see a transaction as being positive for shareholders of both companies. Although Halliburton may not see a short term upside from the deal, it should gain over the long run, as it will be able to expand its suite of products and services and broaden its geographic reach while realizing significant cost synergies.
See Our Complete Analysis For Halliburton| Schlumberger |Baker Hughes
Trefis has a $70 price estimate for Halliburton, which is significantly ahead of the current market price.
BHI Shareholders Get Cash, Swap Shares
The cash and stock deal values Baker Hughes at about $78 a share as of November 12, 2014 representing a 50% premium to the stock price before the news of the negotiations between the companies became public. While the deal comes at a time when Baker Hughes and most large oilfield services stocks have fallen by as much as 30% from their 2014 highs, impacted by lower crude oil prices and a nebulous outlook for upstream capital spending, the offer still represents a 20% premium to the company's 200 day moving average price. While Baker Hughes was by no means in distress before it agreed to the merger, generating positive free cash flows and posting revenue growth, its financial performance has been somewhat weaker and inconsistent compared to its larger peers. Baker Hughes has lower margins compared to Halliburton, and its revenue growth has also lagged behind its larger rival. Since shareholders are slated to receive 1.12 shares of Halliburton stock along with a $19 in cash for each Baker Hughes share, they will in essence be receiving a significant cash premium while holding on to a greater upside opportunity through their ownership of stock in the combined entity.
Halliburton Will Realize Cost and Revenue Synergies
From Halliburton's perspective, the acquisition makes sense for multiple reasons. Firstly, it could result in significant cost synergies. The two companies have a significant overlap in their key product segments such as pressure pumping and completions, and their geographic footprints are also somewhat similar, with both firms deriving close to half of their revenues from North America. Halliburton and Baker Hughes have been among the top players in the pressure pumping space, with pro forma FY 2013 revenues from the segment standing at close to $15 billion (about 29% of total proforma revenues). Since pumping involves significant logistics and raw material costs, there is potential for improving margins by joining forces. Halliburton estimates that the combined entity could yield annual cost synergies of about $2 billion by pruning corporate and administrative costs, optimizing R&D programs and improving organizational efficiencies. Assuming that the company begins to realize the synergies from 2016 onwards, this could translate to a value addition of about $9.5 billion in present terms, assuming a 10% discount rate.
Additionally, the deal could bring about revenue synergies by strengthening Halliburton's product portfolio, while allowing it to make deeper inroads into some geographies. For instance, Baker Hughes is a strong player in the market for artificial lift equipment. The demand for artificial lift technology, which is used to improve production rates from older wells, is expected to grow as wells begin to mature and companies try to extract maximum returns on their investments. The acquisition could also bolster Halliburton's offerings in areas such as production chemicals, oilfield services tools and directional drilling. The deal will also allow Halliburton to make deeper inroads in resource rich markets such Canada and Russia where Baker Hughes has a stronger presence.
Halliburton appears to be paying a fair price for Baker Hughes, valuing the company at about 7.2x its 2015 consensus EBITDA. The acquisition price is slightly ahead of our $71 price estimate for Baker Hughes’ stock, which is understandable considering our discounted cash flow model does not account for synergistic savings associated with the business combination. The total cash consideration for the deal stands at about $8 billion - a sum that Halliburton will be able to comfortably fund by taking on debt and using its cash on hand. Halliburton expects the deal to be cash flow accretive by the end of the first year after closing and EPS accretive by the second year.
Upside Could Come From Better Competitive Position
The deal will help Halliburton improve its competitive position and market power, while allowing it to close the gap with current market leader Schlumberger, a company with a largely diversified product offering and a wide geographic footprint. On a pro forma basis, the merged entity had FY 2013 revenues of $51.8 billion (before potential divestitures), surpassing Schlumberger's $45.3 billion in revenue during the same period. However, Schlumberger's market cap of $120 billion is still nearly 70% ahead of Baker Hughes and Halliburton put together. This is likely related to Schlumberger's higher margins as well as a higher earnings multiple assigned by the market due to its scale and competitive position. Schlumberger trades at about 14.5x FY2015 consensuses while Baker Hughes and Halliburton traded at an average multiple of about 11x as of last week. However, the multiple could increase to account for its stronger competitive position, improved growth opportunities and better bargaining power, potentially increasing the market cap.
Regulatory Hurdles Remain
The deal could face some regulatory challenges since many key product lines in the industry could be dominated by the combination of Halliburton and Baker Hughes. Baker Hughes’ stock closed at around $66 in Monday's trading, well below the deal price, indicating that the markets view the antitrust challenges as significant. For instance, the merged company would hold 36% of the pressure pumping market, 48% of the completions equipment and services market and 49% of the market for cementing services. While Halliburton is looking to placate antitrust concerns by agreeing to sell businesses that generate as much as $7.5 billion in revenues, it believes that regulators would actually ask for considerably less divestitures. Halliburton says that it will pay Baker Hughes a $3.5 billion fee if the deal terminates due to a failure to obtain the required antitrust clearances.
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