Halliburton, Baker Hughes Talk $20 Billion-plus merger

Houston oil services giant Baker Hughes Inc. (BHI) confirmed late Thursday that it's in talks with Halliburton Co. (HAL) about a possible combination.

Baker Hughes said the discussions may or may not lead to any transaction. The company said it doesn't intend to comment further on market speculation or disclose any developments unless it's appropriate or required.

Goldman Sachs & Co. is advising Baker Hughes and Credit Suisse AG is assisting Halliburton, a source told The Deal earlier on Thursday. Suhail Sikhtian is leading the team from Goldman while Greg Weinberger is doing the same for Credit Suisse, the source added.

Bankers at Goldman and Credit Suisse didn't respond to requests for comment. Halliburton hasn't commented.

The Wall Street Journal reported Thursday that a possible deal was in the works, that negotiations were moving quickly and that an agreement could be inked soon. It didn't mention a price.

Analysts think the deal could be worth anywhere from $20 billion to $26 billion, making it one of the largest energy deals in the last few years. It would also create a "juggernaut" in the oil services industry, Global Hunter Securities Inc. analyst Mark Brown wrote in a note Friday.

"We believe that this transaction would be beneficial from a competitive standpoint vis-à-vis SLB [Schlumberger Ltd.] and would make the large-cap diversified players more advantaged when bidding for IPM [integrated project management] and other international work where competitors are limited," he said.

Brown thinks the deal will come in at a premium lower than the average of 30% for oil service companies over the last cycle — certainly lower than the 37% Dresser-Rand Group Inc. (DRC) fetched from Siemens AG in their deal valued at $7.6 billion announced earlier this year. "We expect a lower valuation, particularly if the companies include equity as a component," he said, noting that Halliburton has net debt to Ebitda of less than 1 times and that its debt capacity appears adequate to finance the deal through debt and stock while still remaining at or below 3 times leverage.

Halliburton's timing appears "opportune" given that Baker Hughes has been trading at a discounted valuation versus historical norms, Brown added.

Brian Gibbons and Jake Leiby, analysts at bond research firm CreditSights Inc., suggested a 20% to 25% premium for Baker Hughes, which would be consistent with other large-scale corporate deals over the last few years and 15% over Baker Hughes' recent high. A 50/50 cash and stock transaction amounting to $26 billion with the cash component funded by debt would push leverage up to 1.6 times, which may be unlikely "given this stage of the cycle," the analysts said.

Bill Herbert, co-head of research at Simmons & Co. International, thinks if the deal happens, it will open a Pandora's box to other acquisition candidates, including Dril-Quip Inc. (DRQ) , Frank's International NV (FI) , Oceaneering International Inc. (OII) and possibly Weatherford International plc (WFT) .

Baker Hughes' stock jumped 15.24% on the news Thursday to close at $58.75 while Halliburton's added 1.05% to close at $53.79. Baker Hughes was up 1.5% in Friday morning trading while Halliburton advanced 2.7%.

A deal between the second and third largest players in the oil services industry — which has been hit hard by sliding oil prices — would create a giant with a $70 billion market capitalization but also attract antitrust scrutiny. Schlumberger is the No. 1 player in the industry with a $122 billion market capitalization.

Global Hunter Securities' Brown thinks the transaction would require a lengthy review but most likely would "pass muster on Hart-Scott-Rodino."

Baker Hughes and Halliburton have been thought to have talked merger before, and Schlumberger even made a run at it a few years ago to plug a major hole in completions, which remains unfilled, Simmons & Co.'s Bill Herbert wrote in his note. "Further, GE [General Electric] is lurking in the shadows as well — manufacturing cultures are comparable," he said.

Herbert added that consolidation synergies between Halliburton and Baker Hughes would be massive, with "the chatterati" professing $1 billion. "We'll see," he said.

One investment banking source said a deal seems unlikely, given regulatory hurdles and the mix of businesses. But another said a deal is possible, with the two needing to make some minor divestitures of select businesses to get U.S. Department of Justice approval — similar to the Schlumberger/Smith International and National Oilwell/Varco deals of the past.

Simmons & Co.'s Herbert said Halliburton would likely sell businesses involving wireline, measurement while drilling and logging while drilling, drill bits and some completions. "Given that this is still an Obama DOJ [Department of Justice] and HAL is the acquirer (Cheney legacy, etc.), this could get contentious," he said. "But we assume that HAL's lawyers (asbestos, Iraq, Macondo, etc. — these guys are battle-hardened and competent) have run the traps."

A source for one of the companies' competitors said Baker Hughes' pumping services have been performing poorly since it picked up BJ Services Co. in 2009 for $5.5 billion. The source added that it would be a tough integration for Halliburton since Baker Hughes won't increase its product offering significantly. "They both offer very similar products and services," the source said. "However, all the equipment and products are still different. Do you continue to offer both?"

For Baker Hughes' and Halliburton's competitors, it would mean one less company to bid against. And while Baker Hughes/BJ Services has historically been a low cost provider, Halliburton has not. "Eliminating a low bid is always good," the source said. "If it goes as poorly as the BJ takeover with respect to their service quality, it would be great [for competitors]," the source said.

Philip Adams, an analyst at bond research firm GimmeCredit LLC, wrote in a report late Thursday that both companies have generated cash flow well in excess of capital expenditures, others investments and dividends by $1.4 billion, with Baker Hughes buying back $950 million in stock and Halliburton $800 million. "With this kind of excess cash flow, even in a weakening market, we think a deal would have a significant debt component," he said.

CreditSights' Brian Gibbons and Jake Leiby said the deal came as a surprise, as Halliburton has a much stronger growth, margins and returns profile and the two companies have complementary business lines, including leading positions in the North American pressure pumping market that would face antitrust scrutiny and force divestiture of part of the business. It also thinks the timing seems strange, given contrasting views on oil market direction (with Baker Hughes bullish on its recent third quarter conference call.)

However, the bond analysts think the deal makes sense, mostly because the combined company would truly rival Schlumberger and a re-rating of the combination could ultimately lead to a doubling of Halliburton's stock price. "The deal could signify a coming prolonged period of lower oil prices and that Halliburton and Baker are ahead of the curve on E&P spending cuts and price concessions to come down the pike," they said.

A combination would create a company with $61.2 billion in sales next year, 17% higher than the $52.2 billion that's forecasted for Schlumberger, CreditSights said. Even with the divestiture of part of its North American pressure pumping business, the combined companies would have about the same revenues as Schlumberger and would have Ebitda of $13.5 billion, or a margin of 22%, below the 29% forecasted for Schlumberger.

Thus, the deal would require cost cutting on the order of $4 billion, or 8%, to improve margins to the same level of Schlumberger, CreditSights estimates. "The combined company will have an opportunity to close the margin gap with Schlumberger," the analysts said.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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