Leaner Halliburton refocuses after failed merger with Baker Hughes

Almost from the beginning, Martin Craighead, the chief executive of Baker Hughes, worried about antitrust problems. Under the threat of a hostile takeover, he agreed to negotiate the merger of his company with its larger Houston rival Halliburton, but as the talks proceeded, Craighead repeatedly warned the deal faced trouble with federal regulators.

Halliburton CEO Dave Lesar, however, expressed absolute confidence the merger would pass antitrust muster, forging ahead with a $35 billion deal to create the nation's largest oilfield services company and bring Halliburton closer to the global industry leader, Schlumberger. For Lesar, then 61, the merger promised to be the capstone of a 20-plus-year career at Halliburton.

Two years later, Lesar's misreading of the antitrust climate proved among the most serious miscalculations he made in the determined pursuit of his magnum opus - miscalculations that doomed the merger and added to the carnage of the oil bust, costing many more jobs and billions more dollars beyond those exacted by commodity markets. Halliburton officials concede the $3.5  billion breakup fee they were obligated to pay Baker Hughes was largely responsible for a multibillion-dollar loss in the second quarter that contributed to another 5,000 layoffs.

Today, the companies, both of which have played prominent roles in Houston's economy and history, are diminished. Halliburton, while still a commanding presence in the industry, has scaled back its ambitions, no longer looking for a bold play to catch Schlumberger, but instead focusing on more efficiently and profitably providing the hydraulic fracturing and on-the-ground services it dominates in North America.

Baker Hughes, now a distant third, is desperately trying to reinvent itself. Hamstrung by the merger agreement, the company was unable to make cuts, divestitures and other adjustments that might have helped it to weather the worst of the oil bust and position it for the recovery in oil prices. Despite the $3.5 billion fee from Halliburton, Baker Hughes, which declined to comment, still lost nearly $1 billion in the second quarter and slashed another 3,000 jobs.

"It was very attractive if they'd been able to pull it off," Chris Ross, a University of Houston finance professor, said of the attempted deal. "It was a high-stakes bet and they lost - an expensive mistake for sure."

Interviews with Halliburton executives and analysts, and a review of regulatory filings, show that Lesar, his executive team, and his company became committed to the Baker Hughes deal at the height boom in the summer of 2014. Like so many others in the industry, they discounted how fast and how far oil prices would fall, even though prices had dropped 20 percent by the time they began negotiations with Baker Hughes in October 2014 and then another 12 percent when they announced the deal about a month later.

Halliburton executives also became convinced they could win approval of a merger that would leave the combined company and Schlumberger with a virtual duopoly, controlling up to 90 percent of more than 20 markets. Regulators had approved several mergers, including multiple airline consolidations in the previous years, which analysts believe Halliburton executives took as evidence they could get their deal through. But they missed signals in these cases that the attitudes of antitrust officials toward mega mergers were quickly changing.

Lesar declined to be interviewed. But Halliburton President Jeff Miller, elevated to his post in mid-2014, said these issues only became obvious in hindsight. At the time, the rewards of eliminating a key competitor, gaining market share, and adding new products and services seemed to more than justify the risks - risks that have been largely borne by shareholders and employees.

"We had our eyes wide open going into this," Miller said in an interview with the Houston Chronicle. "We had no illusions about how difficult this transaction would be to do, but firmly believed it was doable."

Miller's time

Costly failures in corporate American mean "heads typically roll in such circumstances," Ross said, but Lesar still remains firmly in power, entrenched as both chief executive and chairman with a friendly board of directors. Still, there are signs that Lesar may be a little less secure as a result of the failed merger. Halliburton recently disclosed in a regulatory filing that it changed its bylaws to allow the largest shareholders to nominate their own directors, a move that could eventually mean a less friendly board.

Miller, meanwhile, is taking a greater role as the public face of a leaner company. A Dallas native who went to McNeese Sate University on a rodeo scholarship, Miller, 52, said the oil bust reached bottom around the middle of the year, and his company now is focused on increasing profits by providing services effectively and controlling costs. Halliburton's goal is to dominate the "last mile" of oil and gas production - the hydraulic fracturing, cementing and other processes that bring a well into operation.

During the bust, 97-year-old Halliburton slashed about 40 percent of its workforce - 35,000 jobs - which accounts for about one in every 10 oil and gas jobs that have been lost worldwide over the past two years. Halliburton, which still employs about 50,000, also is trying to sell its 48-acre Oak Park campus in Houston's Westchase District to consolidate workers into its global Houston headquarters.

Miller called it a "gut-wrenching" process to lay people off. "That's just the harsh reality of what we have to do to size the business to the market that's there," he said.

Halliburton plans to focus on its core businesses, fracking, technology and integrated services for national oil companies abroad, with the aim of producing barrels of oil cheaper and more efficiently than competitors. "It's not sexy but, man, execution is where it happens," Miller said. Halliburton bundles its services of drilling, well completions and fracking much as telecommunications firms like AT&T package cable, internet and phone services. In fact, the last company to pay a bigger fee for terminating a merger was AT&T, which paid $4 billion five years ago when regulators blocked its bid to buy T-Mobile.

Looking back

Halliburton is a decade removed from its vilification during the Iraq war for allegedly overcharging on government contracts and war-profiteering. In 2007, it spun off its defense-contracting arm, KBR, to focus more on energy.

That focus paid off, with Halliburton's revenues more than doubling from about $15 billion in 2009 to $33 billion in 2014. As the energy boom buoyed the company, Lesar eyed Baker Hughes as way to catch up to Schlumberger, which earns about 70 percent more in revenues, in a bold, single stroke.

Halliburton worked with the Baker Botts law firm, NERA Economic Consulting, and Credit Suisse banking giant to study the antitrust risks and put together a plan to divest up to $7.5 billion in business units in the hope of satisfying regulators - not just in the United States, but also in Europe and beyond.

Earlier multibillion-dollar mergers, like the combination U.S. Airways and American Airlines in 2013, may have emboldened Halliburton, said Darren Bush, a law professor at the University of Houston and a former antitrust attorney at the Department of Justice.

The American Airlines deal followed several others in industry that had won approval without too much trouble. But this time, the Justice Department contested the merger, filing suit in federal court to block it. Although ultimately approved after the company agreed to give up nearly 150 landing slots at 7 major airports, it was a clear signal the Obama administration was intensifying its scrutiny of large mergers, analysts said.

Lesar, nonetheless, convinced many shareholders and analysts that Baker Hughes takeover made sense and would come to fruition by the end of 2015. But that date came and went. In April, the Justice Department filed an antitrust suit, saying the merger would eliminate competition in so many product markets - from drill bits to safety valves - that it was unfixable. Television talking heads like Mad Money's Jim Cramer called it the "dumbest deal ever."

"There's a tendency to want to push the limit on big mergers," Bush said. "This showed where the limit stands."

While the $3.5 billion termination fee was a massive sum, it only wounds a giant like Halliburton, analysts said. It also teaches a lesson. Bill Herbert, a senior energy analyst at the investment research firm Piper Jaffray & Co., said the failed merger means Halliburton will focus on fundamentals and keep away from bold and risky plays in the near future.

"It's blocking and tackling," Herbert said. "They're focused on execution, not mergers and acquisitions of any consequence."

Moving forward

One thing remains unchanged, Herbert said. Halliburton is still he "gold standard" in U.S. unconventional shale development - horizontal drilling and fracking - and other services. Better technologies, faster drilling times and improved techniques have made Halliburton nearly 35 percent more efficient and faster in bringing wells into operation since the beginning of the downturn, Miller said.

"In my view," Miller said, "the lowest cost per barrel of oil equivalent is what will carry the day."

The good news is the worst of the oil bust is over, he said. Prices hit bottom at just over $26 a barrel in February. The not-so-great news is it's going to take a while to bounce back as part of the "bathtub-shaped recovery" - a term Miller coined last year to emphasize that won't be the kind of quick rebound often denoted as V-shaped.

As the industry scrapes along the bottom, he said, the fight now focuses on gaining market share and negotiating with oil producer customers to undo deep discounts offered during the bust. Miller says - and many analysts agree - that Halliburton is positioned well because the industry will begin recovering first in U.S. shale, since production there can ramp up faster there than offshore and most international fields.

North American shale is exactly where Halliburton is strongest, and the Permian Basin in West Texas already is seeing an uptick in activity. With global consumption growing and output declining, he said, oil will again be in short supply by as soon as 2020, requiring extra production equivalent to that of two Saudi Arabias to catch up with demand.

"It's still a barroom brawl out there." Miller said. "But I firmly believe at some point in time we'll see that dynamic occur, and we'll be very busy."