Oilfield Services Notes: Halliburton-Baker Hughes Merger Talks, Falling U.S. Oil Rig Count

The oilfield services industry had a very eventful week, with news that Halliburton (NYSE:HAL) was in talks to buy Baker Hughes (NYSE:BHI), in what could be one of largest mergers in the recent history of the industry. Earlier this week, offshore driller Transocean (NYSE:RIG) reported a weak set of Q3 earnings, taking a $2.76 billion writedown that was indicative of a weaker outlook for the deepwater drilling markets. Here’s a quick look at the news that mattered for the oilfield services and offshore drilling sector.

Halliburton In Talks To Buy Baker Hughes

Halliburton – the second largest oilfield services company – is in talks to acquire Baker Hughes, the third largest player in the space. Baker Hughes has confirmed the preliminary talks, and according to people familiar with the matter, a deal could be announced as early as next week if negotiations go through. ^[1] A merger would need to be approved by U.S. and potentially global regulators and could also bring up potential antitrust concerns, considering that it would create the largest oilfield service company in terms of revenues (combined 2013 revenues of $52 billion vs. Schlumberger’s $46 billion). From Halliburton’s perspective, the acquisition makes sense for multiple reasons. Firstly, it could result in significant cost synergies given that both companies are the top players in areas such as pressure pumping and completions, where there will be significant scope to bring down fixed costs. Additionally, the deal could contribute to revenue synergies by strengthening Halliburton’s product portfolio in areas such as horizontal drilling, drill bits and artificial lift while also improving its geographic footprint. We do not see the currently weak crude oil pricing environment as the primary motive for the merger, since this could be a largely transitory factor and the merger is likely to be based on more long-term, synergistic considerations. Baker Hughes investors seemed receptive to the idea of a merger, sending the stock up by over 15% in Thursdays trading, while Halliburton gained 1%. Schlumberger’s stock was down by over 2.5%.

• We have a $70 price estimate for Halliburton, which translates to a market cap of around $59 billion. Our price estimate is about 31% ahead of the current market price. We project the company’s FY 2014 revenues at around $32 billion, with an adjusted EPS of $4.05. This compares to a consensus EPS estimate of around $4.04 according to Reuters.
• We have a $71 price estimate for Baker Hughes, which implies a $31.6 billion market cap. Our price estimate is about 21% ahead of the current market price. We are projecting the company’s FY 2014 revenues at $24 billion with an adjusted EPS estimate of $4.09. This compares to a consensus EPS estimate of $3.97 according to Reuters.

Declining U.S. Oil Rig Count

The oil directed rig count in the United States fell for the second straight week amidst a challenging crude oil pricing environment. Although the U.S. oil rig count had been increasing through this year, rising by 14% year to date, it seems to have peaked off. Rigs targeting oil fell by 14 units to 1,568 as of November 7, the lowest since August 22 and down from a peak of 1,609 rigs on October 10.  ((Baker Hughes North America Rig Count)) Drillers have been scaling back on their operations as crude oil prices have tumbled by about 25 percent in the past four months. Although most large oilfield services companies have downplayed the impact of the falling crude prices on their business, indicating that they haven’t see a pullback in activity yet, we believe that the current environment certainly clouds the near-term outlook for upstream capital spending. While some large producers such as Chesapeake Energy (NYSE:CHK) and EOG Resources (NYSE:EOG) have indicated that they could maintain or even raise their production – likely due to their exposure to the lower-cost Eagle Ford shale – other producers such as Apache and Continental Resources have indicated that they were scaling back in some plays. ^[2]

Transocean Sees A Cyclical Downturn For Offshore Business

Transocean, the largest offshore drilling contractor, has warned that the offshore industry has gone into a “cyclical downturn”, as plummeting oil prices compound the impact of the industry-wide oversupply of ultra-deepwater drilling rigs. The company was forced to take a $2.76 billion write-down during Q3 relating to goodwill impairment and a weaker business outlook for its fleet of ageing deepwater rigs. The number of ultra-deepwater rigs globally is expected to grow to over 160 by the end of this year, while demand (including existing contracts, options and possible contracts) is expected to stand at about 140 rigs. ^[3] The current crude pricing environment is also compounding the impact of the rig glut. Ultra-deepwater is among the most expensive forms of oil exploration and production, and projects could see payback periods rise as revenues get constrained by lower oil prices. According to Barclays Capital, the current crude price decline has erased about $50 billion in cash flow for oil companies and we believe that this could make oil companies more circumspect about their ultra-deepwater rig rental expenditures.

• Trefis has a $34 price estimate for Transocean, which translates into a market cap of $12.3 billion. Our price estimate is about 29% ahead of the current market price. We are forecasting revenue of around $9.23 billion for 2014.  Reuters has a consensus EPS estimate of about $4.63 for FY 2014.
• Transocean’s stock has declined by 10% thus far this week.

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1. Halliburton, Baker Hughes Consider Merger, Bloomberg, November 2014 [↩]
2. Shale Drillers Idle Rigs From Texas to Utah Amid Oil Rout, Bloomberg, November 2014 [↩]
3. Howard Weil Energy Conference Presentation, Transocean, March 2014 [↩]