Why GE announced joint venture with Baker Hughes?

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General Electric (NYSE: GE) recently reached a deal to form a joint venture with Baker Hughes Incorporated (NYSE: BHI), which will be the second largest oilfield services company globally with estimated annual revenues of $32 billion. We believe that GE’s move to forma joint venture and not fully own Baker Hughes, for which GE had to pay approximately $24 billion, is a good bet as the company is getting $7.4 billion from GE Capital from this deal with zero interest rate. Due to the continued downturn in the oil industry, almost all the major oil companies including Schlumberger (NYSE: SLB) are looking for partnerships and acquisitions in order to reduce costs and gain share. Halliburton (NYSE: HAL) had previously attempted to acquire Baker Hughes, which failed due to the opposition from the U.S. Department of Justice. GE has now plucked this opportunity to boost the fortunes of its sinking oil and gas segment business in the current downturn.

The deal is expected to close by the end of 2017 after approval by regulators and Baker Hughes shareholders. The new entity will be able compete effectively against other oil-field services companies by cost cutting and expanding its offerings and distribution.The transaction is expected to be accretive to GE’s earnings per share by $.04 by 2018 and $.08 by 2020. This is assuming that oil prices will reach $60 per barrel by 2020. However if prices recover more than $60 due to OPEC countries expected decision to cap oil production, the accretion has significant upside potential.

 

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Why did GE make this deal?

Last April, Schlumberger completed the acquisition of Cameron International (NYSE: CAM), an oil field equipment and services company, in order to expand into areas with lesser competition. Almost all the major oil equipment and services companies are looking for cost saving mechanisms and exploring new markets where the competition is less to survive the slump oil industry, as crude oil prices continue to remain subdued. GE took the opportunity of failed Halliburton-Baker Hughes deal to form a joint venture with Baker Hughes.

The ‘new’ Baker Hughes will include GE’s oil & gas segment and the old Baker Hughes company. GE will own 62.5% of the new firm and contribute $7.4 billion to fund a special dividend of $17.50 a share to Baker Hughes stockholders. It may seem in the first glance that GE is paying too much for the deal but there is more to it than meets the eye. If GE would have bought Baker Hughes, it would have represented a $24 billion cost.  The company avoided that by forming a joint venture. Additionally, GE secured the funding of $7.4 billion in form of zero interest rate debt from GE Capital, which it spun off recently.

The new Baker Hughes will now be both equipment manufacturer and service provider with sales in close to 120 countries. GE previously sold equipment to Baker Hughes and by forming the joint venture they expect to save $1.6 billion in overall synergies by 2020 giving them the edge over peers who are still relying on restructuring to reduce costs.

 

What is in the store for GE shareholders?

We believe that the two businesses are complementary. Whereas Baker Hughes has a greater focus on North America and terrestrial drilling, GE has notable strengnths in subsea systems and services, turbo machinery solutions and downstream technology solutions.  If crude oil prices recover in the next few years, the new Baker Hughes will leverage GE’s technical innovation, service execution and geographical presence of the joint venture in 120 countries in to compete effectively.

However, there are certain risks that GE investors will have to keep in mind. GE’s recent acquisitions have not been exciting in terms of short term EPS accretion and another deal which is not likely to yield short term EPS may not go down very well with some GE shareholders. Also, if the oil prices do not recover to above $60 by 2020 due to the continued face-off between the U.S. and gulf oil producers, GE will continue to feel the pressure of this industry’s weakness. However, we believe this situation is very unlikely because OPEC countries are expected to reach a deal for capping their oil production in near future and oil prices have already recovered to around $45.

 

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis of General Electric

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