Mr. Market was not impressed by Baker Hughes' (BHI) acquisition of BJ Services (BJS). BHI was down 10% on the day of the announcement, closing at 34.45. BJS was up only slightly, closing at 16.06. Commentators noted that the combination was a good strategic fit, giving BHI a position in pressure pumping similar to that enjoyed by Schlumberger (SLB) and Halliburton (HAL), at the same time compensating for BJS' lack of a strong international presence. Based on the strategic fit, the combination is worth more than the two companies separately.
A three or four way comparison is necessarily complex, but a simple analysis in terms of 5 year average EPS suggests that Mr. Market is getting it wrong:
I did some math on the merger, finding that it is fair to BJS shareholders in that the value received in BHI shares is equal to the value of the BJS shares to be relinquished, using the 5 year earning histories for comparison. Computing a five year average EPS for the combined entity, I arrived at a figure of 4.42.
BHI has said the expense savings in 2011 will be 150 million, or .35 per share after allowing for the shares to be issued in connection with the acquisition. So a proforma 5 yr average EPS, including the projected expense reduction, would be 4.77.
If the global economy and with it the Energy Sector are in recovery by 2011, as seems increasingly likely, then earnings should tend back toward the long term averages. Applying a multiple of 12 to the 4.77 proforma for BHI+BJS, the shares would be worth 57, 65% above yesterday's close.
Disclosure: Long BJS