Why The Baker Hughes Deal Will Eventually Create Value For Halliburton Shareholders

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Halliburton’s (NYSE:HAL) stock has plummeted by about 12% since it announced a $34.6 billion deal to buy Baker Hughes (NYSE:BHI), marking one of the worst performances of an acquirer’s stock this year. Some factors behind the sell off include concerns that the company is overpaying for its smaller rival, since the cash component of the deal doesn’t appear to be covered by the present value of projected cost synergies. We estimate that the present value of cost synergies that Halliburton shareholders would realize stands at $6.1 billion (considering Halliburton’s 64% stake in the combined company and $2 billion in cost synergies per year, discounted at 10%), which is less than the $8.2 billion cash consideration that the company is paying Baker Hughes shareholders. Additionally, the deal is taking place in the backdrop of an oilfield services market that faces a nebulous outlook due to falling crude oil prices. Another concern could be the high termination fees – roughly 10% of the deal value compared to the typical 4% paid by U.S. acquirers this year – that Halliburton has agreed to pay if the merger is called off due to antitrust concerns. [1] We tend to agree that Baker Hughes shareholders appear to be on the more lucrative side of the transaction, at least from a near-term perspective owing to the healthy cash component and the upside they could realize through stake in the combined company. However, we also think that Halliburton shareholders can benefit meaningfully in the long run, since the equity markets seem to favor larger companies with higher market power, greater geographic presence and a depth of product offerings.

See Our Complete Analysis For HalliburtonSchlumberger |Baker Hughes

Trefis has a $70 price estimate for Halliburton, which is significantly ahead of the current market price.

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Markets Could Assign A Better Earnings Multiple

A good way to look at the shareholder value that the deal could create is to compare the combination of the two companies with market leader Schlumberger (NYSE:SLB). 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 $122 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’s FY 2013 adjusted EBITDA margins stood at about 29% according to our estimates, while Baker Hughes and Halliburton had margins of 17.6% and 21.3%, respectively, during the same period. We believe that the combined company should see improved margins owing to better fixed cost absorption and a stronger competitive position. Coming to earnings multiples, Schlumberger trades at about 15x FY 2015 consensus while Baker Hughes and Halliburton trade at an average of  around 11.5x currently and we believe that there is scope for the integrated company to improve its P/E multiple meaningfully given the possibly lower risk profile and higher growth prospects. As Halliburton and Baker Hughes merge, they should realize revenue synergies due to their large geographic footprint and a wider range of products, which should allow them to provide integrated services. For example, Baker Hughes’ strength in artificial lift technologies could complement Halliburton’s mature fields business, opening up more opportunities. Additionally, risks could be mitigated, as the combined entity could have better market power and bargaining leverage, which would allow it to better navigate industry downturns. While Schlumberger is still likely to command a higher valuation premium owing to its technological edge and footprint, if we assume that the combined company is able to improve its multiple to about 13x following the merger, it could create meaningful shareholder value.

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Notes:
  1. Halliburton faces $3.5B breakup fee if Baker Hughes deal fails, Seeking Alpha, November 2014 []