A few days ago I told you to beware because it looked like the deal for Halliburton (NYSE:HAL) to acquire Baker Hughes (NYSE:BHI) was in jeopardy. Make no mistake it has been an absolute bloodbath in the oil sector, and the pain being real, I have felt the long-term investor could start to add to their positions strategically in the oil service sector, rather than dumping now. Prior to the last few weeks, I felt strongly that the acquisition would go through. Now not so much. Independent of the acquisition, I feel that Halliburton is prepared to battle poor oil prices for the next few years. Of course, with the recent developments I discussed, the outlook for the name could be changing. With the threat of the deal falling through, I urged owners of Halliburton and Baker Hughes to watch the lines closely. Just today, the axe fell and my suspicions were confirmed.
We learned that the US Justice Department has indeed filed a civil antitrust suit to block the merger. This news reinforces the insinuations made earlier this week. But why is the Justice Department doing this? Well, they believe that combining the number 2 and 3 oil service companies will essentially crush the competition. Of course, the one powerhouse that comes to mind is Schlumberger (NYSE:SLB). However, the real potential 'victims' would be smaller competitors. It is done to prevent price hikes and maintain the quality of services. This is the point of preventing monopolies, at least, in the spirit of promoting free markets. In a sector like this with multi-billion dollar companies, I think you will not be seeing any 'newcomers', but I digress.
So what does this mean? Well, let me first tell you that the companies are going to fight this tooth and nail as it is in both companies' interests to merge. It is quite likely that the merger would lead to reduced costs in the long run and benefit shareholders. The direct impact to competition is beyond the scope of this article and would require a significant analysis (as opposed to a back of the napkin calculation that I could muster but feel it is disingenuous to do so). The point here is that blocking the merger could hurt Halliburton the most as it will have to burn $3.5 billion in a dealbreaker fee to Baker Hughes.
Now let us not forget that the antitrust concerns were trying to be avoided by having Halliburton sell off assets. Halliburton was ready to dump $7.5 billion in assets to help do this. But recall that regulators wanted the company to sell around $10 billion in assets, 30% more than Halliburton was prepared to do in order to consider blessing the deal. The filing is a setback. The markets are reacting positively because it generally doesn't like uncertainty, and frankly if the deal falls through, big investors know the individual companies and where they stand. Implementation of a merger creates unknowns. This is why I think the stocks are reacting positively.
I want to reiterate that I do not see Halliburton finding buyers for enough of the assets it proposed to sell. Second, those it was proposed to sell did not meet the standards the Justice Department was looking for. What do I mean? Well, in the news announcement for the antitrust suit filing, we learned that:
"During the department's investigation, Halliburton proposed to remedy the significant harmful effects of the transaction by divesting a mix of assets extracted from certain business lines of the two companies. According to the complaint, the proposed divestitures would not include full business units but rather would be limited to certain assets, with the merged firm holding onto important facilities, employees, contracts, intellectual property, and research and development resources that would put the buyer of those assets at a competitive disadvantage. The proposed divestures mostly would allow Halliburton to retain the more valuable assets from either company while selling less significant assets to a third party. The complaint further alleges that this divesture would not replicate the substantial competition between the two rivals that exists today."
Thus, the Justice Department does not feel that leaving Halliburton and Schlumberger as the dominant players here benefits the sector or customers. It remains to be seen if the deal can be saved. Assuming it is not, Halliburton will have to cough up the $3.5 billion. Baker Hughes will go on to struggle as a company as it is barely treading water with oil prices so low. No doubt, the sector has been decimated. Both Halliburton and Schlumberger are holding their own. Does this mean that Baker Hughes could become a casualty should the deal fall through and oil stays this low for years? There is a possibility. I will argue, though, that optically Halliburton needs this acquisition after all of the energy put into it. A $3.5 billion breakup fee is not small item. Expect management changes if the deal falls through.
Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles, which are time sensitive, actionable investing ideas. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."
Disclosure: I am/we are long SLB.
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.