5 Reasons Big Energy Companies Won't Do Deals in 2012 (Correct)

(Oil service M&A story updated to correct for GE purchase of Wood Group well support division)

NEW YORK ( TheStreet) -- Energy stocks are always fodder for the mergers and acquisitions rumor mill, and it's no different in 2012 as the sector isn't lacking for trends to spur M&A.

The North American market is a good place to focus, with oil service companies dealing with a slower pace of growth and increased supply from competitors.

With natural gas prices hovering near historic lows, the entire North American market is moving to focus on oil. The major oil service companies are migrating away from natural gas basins as margins are declining. Oil service companies are also betting international activity increases while the North American market shifts.
Betting on a year of sexy acquisitions by the big oil service companies in 2012 may be wishful thinking: analysts.

Some of the biggest U.S. oil service companies, including Halliburton ( HAL), Baker Hughes ( BHI) and Schlumberger ( SLB) have been highlighted as potential acquirers because of balance sheet strength and the shifting market.

Among acquisition targets, beaten-down, big-name energy stocks are getting a lot of rumor mill play, including those with international businesses, Transocean ( RIG) and Weatherford International ( WFT), and U.S. land driller Nabors Industries ( NBR).

These are interesting deal cross currents for the oil service companies, but also raise questions about the likelihood of today's rumors becoming tomorrow's M&A headlines for the biggest oil service companies.

Here are 5 M&A trends within the oil service business that suggest it may be the smaller companies trying to move up into the world of the Halliburtons that feel the most pressure to consolidate in 2012.

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1. Valuation Doesn't Drive M&A

The slowdown in North America does have some analysts suggesting Halliburton should acquire. "With organic growth on hold for few quarters, we believe now is a good time for Halliburton to consider a large acquisition -- one that would improve the growth outlook either geographically or by product line, and/or create EBITDA earnings before interest, taxes, depreciation and amortization growth through cost savings, rationalization, or scale," Guggenheim Partners analyst Michael Lamotte wrote.

It's been rare that a major oil service company like Schlumberger or Halliburton makes a deal with valuation being the primary trigger, though.

"These companies are looking to plug holes in their technology portfolio or geographically. Valuation-based M&A speculation can get silly," said Johnson Rice analyst David Smith.

How silly? Nabors and Transocean may both be among companies now deemed "cheap" as acquisition targets, but in October 2011, the rumor being reported by CNBC was that Transocean was going to buy Nabors. More recently, Bloomberg reported that Schlumberger or Baker Hughes might be a likely acquirer for Nabors. Since then the rumor mill has buzzed with reports that Brazilian oil exploration and production giant Petrobras would consider a bid for Transocean.

When it comes to the oil service companies, though, M&A rumors come and go much more quickly than the time it takes for a deal to actually come together.

Johnson Rice's Smith said, "The deals these guys do are long-term focused, and they've often been working on them for a long time before the deal announcement. Deals don't happen just because the North American market is starting to slow down or valuation all of a sudden makes a company 20% more attractive."

Even when a drop in the share price might make a previous discussion look more attractive to the seller, buyers don't generally wake up and say 'I'm going to initiate a deal because some other company's stock price is cheaper today,'" Smith added.

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2. Strategic Fit Comes First, and Doesn't Come Quickly.
Michael Marino, analyst at Stephens, said he can't see a reason why any of the large-cap oil service companies would need to go out and make a mega-acquisition.

Looking back at the recent big deals made by them top three companies -- Schlumberger, Halliburton and Baker Hughes -- there has been an overarching strategic reason for each.

When Schlumberger acquired Smith International it was mostly about integration of Smith's fluids business.

The Baker Hughes acquisition of BJ Services was discussed for a long time and the rationale was that service intensity was growing rapidly and it filled a hole for Baker Hughes.

Halliburton's acquisition of Boots & Coots expanded its platform for a focus on servicing the brownfield (mature reservoir) market.

The oil service analysts don't see a "cheap" large-cap name like a Transocean or Nabors fitting any overarching strategic need.

Morgan Keegan analyst Roger Read said that Nabors might be worth more if its assets were broken up. "Nabors has had a lot of acquisitions over the last 15 years and little in the way of dispositions. Does it all make sense to be together?" asked Read. The argument that the parts are worth more than the whole merits M&A chatter, but it doesn't mean that any of the oil service majors would be interested in the company.

Several analysts agreed that Nabors would not be an attractive candidate for an acquisition by an oil service major because it is a "jack of all trades rather than a master of one." If an oil service major wanted to buy a land driller in the U.S., Helmrich & Payne ( HP) is a lot cleaner as a play on land drilling, Marino noted.

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3. The Large-cap Oil Service Companies are Likely to Stay Off the Radar
Morgan Keegan's Read said the large-cap oil service companies have tended to make their biggest acquisitions during global market slowdowns. What is occurring right now in North America doesn't rate as a global slowdown and suggests that the companies continue to focus on bolt-on acquisitions adding specific lines of expertise.

"In cycles where commodity prices decline and then you see a drop in activity there is a focus on consolidation and market share. But today if you merge two companies you may lose a ton of people and management might end up being distracted and end up with less market share," Read said.

Halliburton announced in its recent fourth quarter and full year results that it had made $880 million in acquisitions, however, these are the type of off-the-radar acquisition that don't hit the headlines and Marino said that Halliburton has been clear that its acquisition focus remains on technology.

"Larger companies won't just buy a competitor's capacity because it's getting cheaper, and if it's getting cheaper, they might wait to see if there is even more pain involved," Smith added.

National-Oilwell Varco ( NOV) told analysts this week that it is focusing on making acquisitions in a range of $250 million to $750 million, a range that suggests more niche expertise acquisitions, not mega deals.

National-Oilwell Varco this week said it would acquire NKT Flexibles for $670 million. NKT makes flexible pipe products and systems for the offshore drilling.

In announcing the deal, Pete Miller, CEO of National-Oilwell Varco, stated "The incorporation of NKT's highly technical design capability and business into our Rig Technology group is an exciting and strategic opportunity for NOV."

Late last year, NOV closed on a $772 million acquisition of fiberglass company Ameron, showing that even at the top end of the valuation range it laid out again this week, it has been focused on specialty plays related to core oil services.

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4. International Acquisitions aren't Necessary to Spur International Growth
Halliburton has failed several times in recent years to make a major international acquisition. Halliburton was outbid in 2008 by private equity when it bid for Expro, and was widely believed to be interested in Wood Group's well support division, which General Electric ( GE) acquired last year.

Yet Smith said Halliburton made the right move in not letting itself get caught up in a bidding war with a GE or the private equity industry at the peak of the market, and the company can continue to grow internationally without a major international acquisition.

"Halliburton is large enough already internationally. There is no pressure to grow internationally to offset softening in North America," said Smith.

Marino added that when the international acquisition campaign failed, Halliburton took the organic approach. The Stephens analyst said the pressure will be on Halliburton to prove that the organic growth is enough: "Now that offshore and international are picking up, we will see how they have done."

In addition to Transocean, Weatherford International has been a staple of rumors, but the analyst community seems to think that a Weatherford still makes more sense for a GE as its builds out its energy portfolio, rather than a large-cap oil service company, which doesn't add any particular expertise that it needs to win business by adding Weatherford.

While Weatherford could be attractive because of its exposure to the recovering international market and its more limited exposure to North America, that doesn't mean a large-cap oil service company is the right fit: "If you're Halliburton and you think the international market is ready to go gangbusters, you don't want to miss what could be an up market because you are trying to integrate an acquisition. Just ride the tide and go with what you've got," Marino argued.

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5. Look to the Miid-cap Oil Service Companies for M&A

International is one area among several where the oil service analysts said it might be better for investors to look to mid-cap companies as likely M&A participants.

As far as a potential slowdown in the onshore U.S. market and growing international shale activity, it could spur some of the smaller players that are concentrated in pressure pumping if they are looking to grow internationally to make deals to provide more of a bundled service.

"Internationally, there is less demand for a la carte services, so it might be less than optimal to compete with just pressure pumping capacity," Smith said.

Companies a level down from Halliburton and Schlumberger, like mid-cap oil service company Key Energy Services ( KEG) or land driller Patterson-UTI ( PTEN), are just as likely if not more likely to feel pressure to grow by way of acquisition.

"I'm pretty skeptical on large scale M&A," Marino said. "The bigger North American players that aren't the Big Three need to look at opportunities. The small and mid-cap names will want to scale up against the Halliburtons," Marino said.

-- Written by Eric Rosenbaum from New York.


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