Halliburton: Drilling Into the Deal Math
Merger Could Make Sense on Paper, But Hurdles Loom
And on paper, at least, purchasing Baker Hughes BHI +1.94% could make sense for Halliburton. HAL +2.40% But the potential backlash presents a big hurdle to getting a deal between the two oil-field services giants whose talks were revealed by The Wall Street Journal last week. Little wonder there is tension between the two sides and the real possibility that Halliburton goes hostile.
Crucial parameters such as price aren’t publicly known. Assume, though, that Halliburton pays a 30% premium to where Baker Hughes’s shares closed on Wednesday before the news broke. That would imply a price of $66 and change per share, 11% above where Baker Hughes was trading on Friday.
At an implied value of $28.7 billion versus Halliburton’s own market capitalization of $46.7 billion, much of the price tag would have to be paid in stock: Assume 70% with the rest being cash. That would leave the combined company with manageable net debt of about 1.5 times earnings before interest, taxes, depreciation and amortization.
Together, Halliburton and Baker are forecast to make $9.5 billion in earnings before interest and taxes next year, using FactSet data. Assuming it pays 5% interest on combined net debt of $17.6 billion—which includes the $8.6 billion of new borrowing to fund the cash paid to Baker Hughes’s shareholders—earnings before taxes would be $8.6 billion.
Assume an effective tax rate of 32.5% and net income would be $5.8 billion. Factor in the new stock issued to Baker Hughes’s investors, and earnings in 2015 come out at $4.77 per Halliburton share—two cents lower than the current consensus forecast.
Now factor in synergies. Assuming 5% of Baker Hughes’s costs could be eliminated—a typical rule of thumb—this would add $1 billion to annual pretax profits. Plug that into the model, after factoring in some upfront costs and taxes, and combined earnings jump to $5.34 a share—11% higher than analysts’ current estimate.
The other big, though more abstract, prize is the potential for the combined company’s shares to be awarded a higher stock-market multiple to reflect its better competitive positioning. At Wednesday’s close, the average multiple of 2015 earnings for Baker Hughes and Halliburton was 10.8 times, a 28% discount to bigger rival Schlumberger. SLB +0.50%
Say Halliburton-Baker closes that gap by half, implying a new multiple of 12.9 times. Applying this to the pro forma earnings figure results in a market value of almost $84 billion—25% more than Wednesday’s combined total.
All these numbers are highly malleable, especially with oil prices moving rapidly, but two things are clear: First, there is enough potential money on the table to justify a conversation. Second, realizing those riches would rest squarely on a bigger company not only extracting synergies but also being rewarded with a higher stock multiple.
Therein lies the deal’s big challenge. Halliburton and Baker Hughes combined would effectively create duopolies in at least four different business areas, controlling, along with Schlumberger, between 70% and 90% of the market for things like well logging and drill bits, according to Kurt Hallead of RBC Capital Markets.
That would be bound to alert antitrust regulators, likely egged on by oil companies not thrilled at the idea of suppliers getting together just as energy prices are sinking. Even if a deal were approved, the remedies required could eat into both the synergies and the potential gain from the stock being given a higher multiple.
The potential rewards of a Halliburton-Baker deal could be big, but getting them from the spreadsheet to Wall Street would be tough.