Monday, November 24, 2014

Audacity of Hope: Halliburton - Baker Hughes Acquisition

The energy sector is under immense pressure due the collapse in oil prices. This will drive M&A activity as firms seek to adjust. Halliburton, the oil services industry  #2, made a $35B Bid for Baker Hughes, the #3 player, in an attempt to close the operating and valuation gap with industry leader Schlumberger. It represents a large, richly priced and risky transaction.

Ordinarily, the buyer’s price falls following a bid reflecting investor concerns with the deal such as being over priced. Usually, the pro forma value of the combined entity, however, increases. In the Halliburton situation, the combined value actually fell. It reflects both a 10%+ drop in Halliburton’ stock price and Baker Hughes trading at $66 p/s compared to the $78 p/s offer price-which illustrates investor concern with the deal’s large antitrust hurdles.

My issues with acquisition are as follows:

1)     Size: the target is almost the same size as the acquirer. This raises integration issues.
2)     Premium: the 50%. My belief is anything over 40% for a major transaction is difficult to justify.
3)     Shareholder Value at Risk (SVaR): SVaR, combination of premium and size, is huge making this a potential “bet-your-company” type of deal. Halliburton’s management is risking 50% of its shareholders’ pre bid value on this deal.
4)     Antitrust Risk: Halliburton will pay Baker Hughes a $3.5B breakup fee if the deals fails to obtain antitrust approval. This is a significant issue given the combination of the industry’s #2 and #3 firms. Some estimate divestments representing $7.5B of sales may be needed to obtain approval.
5)     Consideration: the deal is 25% cash. Halliburton is using its stock, which trades near its 52 week low, to fund the remaining 75%. The use of potentially depressed under valued stock constitutes another source of over payment.
6)     Synergies: the estimated $2B in cost cuts exceed what observers had estimated-especially in a down market. Projections should reflect reality. Here, I wonder if reality is not being reshaped to fit the projections.

The deal is being justified as strategic, and it may well be. Nonetheless, it must still make financial sense. I am reminded of my former boss who used to say “strategic” is a code word for “over priced”.

Halliburton must have been influenced by President Obama’s book-The Audacity of Hope”. Hope, however, is never a good M&A strategy. Hewlett Packard is the current poster boy of bad acquisitions. I think Halliburton is making a strong move for that dubious honor with the Baker Hughes transaction. No wonder why their shareholders are so concerned.


PS  We will not publish Thursday in observance of the American Thanksgiving Holiday.  To all of our friends worldwide, we wish you peace and happiness with your families. 

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