Why Smith Has Few Alternatives to Schlumberger

 |  Includes: BHI, BJS, HAL, SII, SLB
by: Anthony Alfidi

Boards of publicly held companies have a duty to maximize shareholder value. Attorneys are wondering whether the board of Smith International (SII) has done all it can:

The investigation concerns whether the Smith Board of Directors breached their fiduciary duties to Smith stockholders by failing to adequately shop Smith before entering into the merger agreement, and whether Schlumberger is underpaying for Smith shares, thus harming Smith stockholders.

The first question is easier to answer than the second. Baker Hughes (NYSE:BHI), a major competitor, is preoccupied with its acquisition of BJ Services (BJS) and would be hard pressed to make a competing bid for SII. Halliburton (NYSE:HAL) has a much larger market capitalization than SII and could presumably make a stock offer that has less of a dilutive effect than Schlumberger's (NYSE:SLB) offer. However, HAL seems to be more focused on pursuing organic growth rather than acquisitive growth as a strategy. It is thus easy to give SII the benefit of the doubt for taking SLB's offer.

The second question of whether the offer represents best value is more difficult to assess. SII's P/E ratio is currently over 61, pricing this company at a massive premium relative to its peers. SII shareholders should be impressed that the market is valuing its prospects as if it were a growth company rather than a seasoned producer in a mature industry. SLB is arguably paying a huge premium for SII's topline revenue, betting that its decline in revenue last year is temporary and can be ameliorated in a combination. Failure to complete this bid would relegate SII to competing against three super-large competitors with stronger balance sheets and operating margins. Only a surprise offer from another firm can definitively prove that SLB's offer for SII is too cheap.

Disclosure: Short puts under SII expiring March 2010, no other positions in stocks mentioned.