It’s no coincidence that the proposed merger of the second- and third-largest oil field services is coming together against the backdrop of the biggest drop in oil prices in nearly five years.
No. 2 Halliburton and No. 3 Baker Hughes reached agreement in mid-November on a $34.6 billion deal that would, upon consummation and the expected sale and/or spinoffs of certain units to appease antitrust regulators, make the combined company almost as big and powerful as Schlumberger, currently the global leader in oil field services.
Decreasing Oil Prices Push Companies to Lower Costs
After a historic decade-long run of good fortune and profits, the oil industry finally has entered a period that, while it cannot be fairly called rough times, does qualify as something of a downturn. Oil prices have tumbled more than 25 percent since their summer peak, with West Texas Intermediate Crude selling at around $75 a barrel. From a historical perspective, that’s still a healthy price, and one at which oil companies and energy services companies should be able to profit.
But it’s quite a come down from the high times of $100-plus a barrel oil of a few years ago, or the $95-plus a barrel price at which it has sold for the past year. And, while oil companies a decade ago would have earned huge profits selling oil at $75, their operating costs have risen dramatically in recent years. Many companies plowed much of the cash produced by operations back into exploration, refining and product development.
Those higher operating costs, in fact, are one of the key reasons Halliburton officials gave for their company’s bid for rival Baker Hughes. Indeed, buying out a competitor in hopes of reducing costs (and eliminating some degree of price competition) as markets head into a turndown is a textbook move for big time CEOs. Baker Hughes itself is the product of that popular strategic move. Twenty-seven years ago, Hughes Tools Co. and Baker Oil Tools formed Baker Hughes in a $1.2 billion merger as oil prices began to fall back from then-remarkable highs near $19 a barrel. That downshift in prices forced oil companies and oil services companies to scramble to cut costs, and the merger of Baker and Hughes did just that.
Halliburton-Baker Hughes Merger Could Save $2 Billion Annually
Now, energy companies are scrambling once again to cut costs that have gotten too high. Oil producers have slashed the number of drilling rigs over the past couple of months, directly impacting the oil field services companies that supply much of the technology and hardware at drill sites. Halliburton CEO Dave Lesar says the announced merger with Baker Hughes could result in operational cost savings of $2 billion a year once the dust is settled.
Assuming oil prices stabilize in their current $75-a-barrel zone, most of that $2 billion will go to shareholders in the form of dividends or, more likely, share price gains. Once the merger is completed, probably sometime in 2016, the merged Halliburton also hopes to see a significant narrowing of the share price valuation gap that exists today between the shares of Schlumberger (valued at 14.5 times the company’s earnings per share) and the shares of both Halliburton and Baker Hughes (which are both valued at 11 times the company’s earnings per share). Currently, Schlumberger enjoys that valuation premium because of its much larger global footprint, market share and revenues as well as its dominant position in a number of specialty service areas.
After the merger, however, the new Halliburton will be almost as big as Schlumberger in terms of revenue (perhaps even bigger if it successfully limits the number of units it must dispose of to win anti-trust approval). And it will be a stronger competitor in certain regions, including Canada and Russia, and the clear global market leader in several key specialty services markets such as pressure pumping, completion equipment and services, production chemicals, oilfield tooling, directional drilling and artificial lift technology.
That expertise in artificial lift technology, which Baker Hughes is bringing into the marriage, should be particularly valuable going forward as it is used to increase production rates from older oil and shale gas wells. Oil producers are expected to increase their use of this technology over the coming decade as many of their big-producing wells age and need an extra boost to continue the high rates of production on which the producers’ investments hinge.
Success of Merger Can’t Be Determined
Would Halliburton and Baker Hughes leaders ever have tried to merge, and even if they did would they have been successful in negotiating a deal had the price of oil not fallen so far so fast? Maybe, but probably not. Clearly the drop in crude prices made it not only easier, but likely that such a deal would occur.
That does not, however, guarantee the success of the merger. While the Baker-Hughes merger of 1987 worked out beautifully for shareholders and the long-term survival of the two companies, there’s no guarantee that the Halliburton-Baker Hughes merger will meet with the same success. Downturns can present conditions that are ripe for consolidation and cost savings, but they can also present enormous challenges.
The file cabinets in U.S. bankruptcy courts around the nation are full of cases of companies that sought protection from their creditors after expected cost savings – and revenue synergies – from a merger amidst a downturn failed to appear. The Halliburton-Baker Hughes merger would not, on the surface, seem to become a failed merger, even if oil prices fall much lower than they are today. But there’s always risk in such cases.
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