Baker Hughes - Big Merger With Activist Backing

| About: Halliburton Company (HAL)

Summary

Baker Hughes has fell 20% over the last year despite a buyout offer.

Weakness in the oil markets could pull BHI down further, providing a buying opportunity.

Both companies, and an activist investor, are committed to getting the deal done.

All the way back in 2014, Halliburton (NYSE:HAL) and Baker Hughes (NYSE:BHI) announced a merger deal that would combine two of the oil services industry's largest providers. Since then, Halliburton shares have tumbled 43% and Baker Hughes is off 18%.

The consolidation comes as the industry continues to struggle with low oil prices and a focus on cost controls. Consolidation is a focus for the industry as challenges and other large companies use mergers and acquisition to improve their own cost structures. Exxon (NYSE:XOM) is one example of a large conglomerate who has been actively taking advantage of acquisition opportunities in the industry - although not as much as some investors would like. Meanwhile, the merger of Schlumberger (NYSE:SLB) and Cameron International (NYSE:CAM) also highlights the need for oil servicer companies to band together.

Once completed, the merger of Halliburton and Baker Hughes is expected to generate cost synergies of $2 billion annually with accretive cash flows in the first year and accretion for earnings per share in the second year. The reasons are solid.

In Halliburton's most recent third quarter it reported total revenue of $5.58 billion, down 36% from the comparable quarter, and earnings per share of $0.31, down 30% from the previous quarter. Baker Hughes reported revenue of $3.79 billion for the third quarter, down 39% from the comparable quarter, and an EPS loss of $0.05, up slightly from the $0.14 loss in the previous quarter.

Enter the activist

A majority shareholder in both companies, Jeff Ubben of ValueAct, is a big supporter of the deal. Holding right at 5% of Baker Hughes and Halliburton, the investor says the deal will greatly help both companies to control costs and enhance efficiencies in a difficult market environment for the energy industry.

While the benefits of the deal are clear, the market hasn't appreciated it - hence the selloff in the stocks. However, they're working against a bigger force here - lower oil prices. Then there's the other big issue, and one that's a big overhang, regulatory approval.

Baker Hughes is trading at a 20% discount to Halliburton's takeout offer. The regulatory review is underway in a number of countries. The biggest hurdle is in Europe, where the EU is questioning market competitive factors following the acquisition. The EU is questioning monopolized effects on oil prices and energy services that could potentially be a result of the merger, specifically following the recent merger of Schlumberger and Cameron in August of 2015.

Halliburton say that it will comply with the EU and initiate any necessary modifications needed to gain approval (and Jeff Ubben has reiterated this sentiment in the past - that HAL will do whatever necessary to get the deal done).

This investigation still lengthens the approval process for the oil service providers and could further negatively effect the market premium as energy stocks continue to be volatile.

Overall, the Halliburton-Baker Hughes deal still has enough positives and is a way to manage oil price pressures. Both companies sentiment to get the deal done is a positive and they have the activist hedge fund, ValueAct, putting pressure on them to get this done. All positives that have us interested in Baker Hughes - as the discount to the acquisition price seems overdone. Granted, the big risk is lower oil prices and a further drop in Halliburton stock. In the deal you'll get 1.12 shares of Halliburton and $19 in cash. Owning shares of Halliburton isn't a complete negative, as it will be a formidable opponent to Schlumberger after the Baker Hughes buy. But we're still playing wait-and-see, as the deal will likely take most of 2016 to close, but are on the lookout for a good entry point at Baker Hughes - i.e. somewhere back below $40 a share.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.