Another Marriage in the Oil Patch

The PGS-Veritas combination could be a harbinger of things to come in the troubled oil sector.
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In a sign of these consolidating times in the oil patch, Norway's

Petroleum Geo-Services

(PGO)

agreed to acquire Houston-based

Veritas DGC

(VTS)

for slightly more than $770 million in stock.

The deal, which would create the world's second-largest seismic-data and geological-data firm, represents a 38% premium for Petroleum Geo-Services shareholders based on Monday's closing prices. They would receive 0.47 share of the new company, valued at $7.56 based on Monday's closing price, for each share of Petroleum Geo-Services they own. Veritas shareholders would exchange each existing share for one share of the new company. Petroleum Geo-Services closed Monday at $5.46, while Veritas closed at $16.05.

The companies, which provide mapping services and research data to exploration and production companies, will be based in Houston and have a market cap of about $1 billion.

While limited in its implications for the broader energy-services sector, this combination may signal the type of deal to come in the depressed oil business. As prices of commodities fall, and exploration and production companies react by scaling back spending plans, energy-services companies -- from drillers to seismic-data providers -- will look for cost savings and synergies to remain productive. This deal provides those benefits.

"The merger is significant to the seismic industry in that you are taking the second- and third-largest players and putting them together in an industry that has seen fierce competition and a generally lousy return on investment," says Dan Pickering, director of research at Simmons & Co., a Houston energy investment firm, and a member of the

TSC

Energy Roundtable. "In this environment, that is a positive for both companies as well as for the industry as a whole."

The newly combined companies should challenge

Western Geco

, a joint venture between

Schlumberger

(SLB) - Get Report

and

Baker Hughes

(BHI)

and the largest seismic-data provider, for leadership in sophisticated mapping and exploration for new sources of energy.

"The combination of Veritas and PGS will enable us to offer fully integrated services to our customers and will give us the strength, flexibility and resources to compete more effectively and efficiently on a global scale," said Reider Michaelsen, chairman and chief executive officer of PGS, and Dave Robson, chairman and CEO of Veritas, in a statement announcing the merger.

Synergies and Capacity

As industry players have seen the prices of their underlying commodities -- crude oil and natural gas -- fall precipitously in the past year, their ability to cut costs and create synergies through scale become increasingly important.

The companies say they'll be able to slash $35 million in annual costs before taxes, and they suggest the deal will be immediately accretive to earnings. "We saw both companies, independently, earning around 85 cents

a share next year," says Pickering. "Combined, we think the new company will earn $1.10 or more. That makes this a solid combination."

That number could increase if the companies can reduce the capacity of seismic services and push prices higher. "One of the challenges has been the growth of seismic capacity in the last up cycle," says Pickering. "While it's unclear what the combined companies will do, it is likely they will probably idle some of their boats. This is clearly an opportunity to remove some of the excess capacity from an oversupplied market."

Who's Next?

According to the energy group at Raymond James, "This is a positive step for consolidation in the sector and could indicate further deals in the future. The possibility of other deals could buoy stocks of other seismic companies in the next few days."

If so, companies such as

Geophysique

(GGY)

,

Seitel

(SEI)

and

Input/Output

(IO) - Get Report

could stand to benefit from the trend.

But Pickering cautions investors not to carry the possibilities too far. "This is not necessarily a harbinger of a wave of consolidation in the whole oil-services sector," he says. "Each subsector seems to operate with its own dynamic. This won't spur mergers in the offshore drilling business, for example."

Yet in a sector that has lost its footing, every little bit can help.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, Edmonds' firm was had no positions in any of the securities mentioned, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to

Chris Edmonds.