Baking a deal
Baker Hughes may be worth more than investors think. Shares of the No. 3 U.S. oilfield services firm jumped 15 percent on Thursday after news broke of deal talks with the $46 billion Halliburton. A back-of-the-envelope calculation suggests the industry No. 2 should be willing to pay nearly 40 percent more than Baker Hughes’ $22 billion undisturbed market valuation to seal a deal.
Baker Hughes has confirmed preliminary discussions with Halliburton and recent ructions in the energy world provide a fresh rationale for a combination that is regularly rumored. Shares of companies that provide specialized drill bits, hydraulic fracturing know-how and the like to oil majors have been battered by the 30 percent plunge in the price of oil since June. Investors fear a long downturn for services firms as their customers slash spending plans. A stronger runner-up to $120 billion sector leader Schlumberger might have more negotiating clout.
But cost cuts would be at the center of any deal. Past oilfield services mergers offer a guide. Baker Hughes’ own purchase of BJ Services in 2009, Schlumberger’s takeover of Smith International in 2010 and Siemens’ deal for Dresser-Rand in September all targeted annual cost savings of between 4 percent and 6.5 percent of the target company’s top line.
Suppose Halliburton could, over three years, squeeze out costs equal to 5 percent of Baker Hughes’ revenue. Applied to Wall Street’s average estimate of $26 billion of revenue for the company next year, that’s $1.3 billion in annual savings. Taxed and discounted to a present value, these would be worth $8.3 billion today. If Halliburton handed all that value to Baker Hughes’ shareholders to win them over, that’s nearly a 40 percent premium to the smaller company’s market value at the close on Wednesday.
There are anti-trust risks to consider, and integrating two fierce competitors would be challenging. Such concerns help explain why investors haven’t pushed Baker Hughes stock up further. Of course, no potential buyer would start with a top-dollar bid – especially in cash when a downturn may be in the offing. But Halliburton might offer shares. And the arithmetic suggests a deal worth over $30 billion could add up. That leaves room for a further 15 percent-plus gain on Baker Hughes shares.