Musings: HAL/BHI Deal - Transformational Or Just Shifting Deckchairs?

Musings: HAL/BHI Deal – Transformational Or Just Shifting Deckchairs?
The recent agreement for Halliburton to acquire Baker Hughes sparks industry speculation as to the significance of the purchase for the global oilfield service industry.

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The recent agreement for Halliburton Companies (HAL-NYSE) to acquire Baker Hughes Corp. (BHI-NYSE), in what was reported at the time of the announcement of the deal as a $36 billion cash and stock transaction, sparked industry speculation as to the significance of the purchase for the global oilfield service industry. It is certainly a significant deal for the two companies, and was driven by Halliburton’s perceived need to gain increased global scale, as well as to fill out product lines in which the company was weak and needed greater heft to better fulfill the needs of its global customers, and potentially be better positioned to weather industry cycles. According to data from oilfield market research firm, Spears and Associates, the two companies have meaningful overlaps in at least 10 product lines. These overlaps create a challenge for Halliburton’s management in securing approval of the transaction from regulators both in the U.S. and other foreign jurisdictions where the companies operate. Besides seeking regulatory approvals, Halliburton still needs to convince its customers that: bigger will be better.

According to correspondence released by Baker Hughes as the negotiations were underway, the transaction was first proposed by Halliburton on October 13th, after both companies had released their third quarter 2014 financial results. Both managements commented to the investment community about their financial results and their respective views of future business activity in light of the then-recent fall in global oil prices. Halliburton’s Chairman and CEO Dave Lesar spoke optimistically about the downturn being of short duration, while Baker Hughes Chairman and CEO Martin Craighead was more guarded saying that the industry correction would last longer and provide greater business challenges. After the Dow Jones Newswire broke the story of the discussions in the early afternoon of Thursday, November 13th, Halliburton declined to comment while Baker Hughes acknowledged the talks but said it would have no further comment. Surprisingly, the price of the companies’ shares rose immediately after the news report and then continued to climb the following day, signifying that Wall Street believed the combination would be positive for both companies, although there had been no hint of the potential terms of the deal, which would impact the value of the deal for each company.

As the negotiations between the two managements and their advisors progressed on Friday, November 14th, the media was franticly sampling the views of Wall Street energy analysts and antitrust lawyers about the possible terms of a deal, whether the transaction made business sense, and the regulatory hurdles that it might have to overcome. About the time the ink was dry on these articles, news broke that the discussions had broken down over the purchase price (it appeared from the Baker Hughes letters and emails exchanged with Halliburton) and the terms of divestments. Almost immediately Halliburton notified Baker Hughes it was prepared to nominate a slate of directors to oppose the current Baker Hughes board of directors at the 2015 annual meeting. Prospects of a protracted proxy fight seemed clear absent a deal.

In the early morning hours of Monday, November 17th, came the announcement of the deal in which Halliburton would offer 1.12 shares and $19 in cash for each share of Baker Hughes, valuing the company at $78.62 a share, more than a 40% premium over where the stock had been trading. The transaction announcement also disclosed that Halliburton had identified businesses generating $7.5 billion in revenues that would be sold, and that the company and its advisors had already identified candidates to buy these businesses. Due to the antitrust hurdle and the perceived harm that would be done to Baker Hughes if the deal had to be abandoned, Halliburton agreed to pay Baker Hughes $3.5 billion. It subsequently was disclosed that Baker Hughes would pay Halliburton $1 billion if the deal failed to close due to various conditions. The transaction should close during the second half of 2015 after all regulatory approvals are secured.

As we pondered over the weekend following the announcement of the talks the prospect of a proxy fight in the spring, we were reminded of a similar management hardball negotiating episode during the creation of Baker Hughes. In early 1987, the energy business was still reeling from the first half of 1986’s oil price collapse engineered by Saudi Arabia. By the spring (May 18th) of 1987, the domestic active drilling rig count stood at 744 rigs after having fallen by 84% from the industry’s 1981 peak of 4,530 active rigs. Not only was demand for oilfield service at a low, but pricing discipline in the industry had been destroyed by the desperate actions of smaller, financially-weak competitors who were willing to discount their services and products merely to generate cash.

In the fall of 1986, Baker Oil Tools, as the company was then known, had approached the Hughes Tool Company with an offer to merge. A deal was struck. The problem was that the Reagan Justice Department announced it would sue to block the merger on antitrust grounds unless two divisions of Baker were sold. Justice demanded that Baker sell Reed Tool, its tri-cone drill bit manufacturing business, and Baker Lift, its manufacturer of downhole electric submersible pumps. Both businesses competed with Hughes, and the government believed that their combination would significantly reduce competition in the oilfield service industry.


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