The long wait is finally over; the U.S. Justice Department has announced it will sue to block the merger of Halliburton and Baker Hughes. This makes the merger much less likely to be consummated – so much so that I think it’s fair to operate using a base assumption that the deal is dead, even if that position is not yet official.
A key tenant in industrial organization theory is that it takes three strong competitors to make an efficient market. Without three competitors, industries and companies fall prey to problems of tacit collusion, resulting in slowly higher prices and less overall economic efficiency.
The HAL/BHI merger was done in by the lack of a third strong competitor. While Halliburton showed a willingness to do whatever it took to get the deal done by agreeing to divest billions of dollars of assets, in the end it was not enough. The problem with the deal was the same problem that drove the need for the merger in the first place; low oil prices.
Halliburton and Baker Hughes agreed to the merger on the basis of the need to become more efficient to cope with the new lower oil price environment. That same constraint made very few firms willing to step up and invest the capital necessary to buy the assets Halliburton was selling at any kind of a reasonable price. For the vast majority of OFS firms out there right now, this is a time for caution, not aggressive behavior.
That reality became abundantly clear when Weatherford, a prime candidate to become the third strong competitor after the Halliburton-Baker Hughes merger, was forced by its shareholders to drop out of bidding for new assets from Halliburton’s divestiture pool. At the end of the day, only GE showed much of a willingness to bid on many of the assets. This in turn led to weak offer prices to Halliburton and led government regulators to question the feasibility of creating a new third competitor.
So what comes next for Baker Hughes and Halliburton? In the short-term, both companies will face pressure, but that pressure will be particularly acute for Halliburton, which now owes Baker Hughes a hefty $3.5B break-up fee – certainly a very nice consolation prize for the Baker Hughes and its shareholders. One might suspect that Baker Hughes negotiated that rich breakup fee because it was somewhat skeptical of the deal coming to fruition in the first place. Such fears have been proven sage.
Baker Hughes’ newly refilled coffers should give the company ammo to buy back a significant portion of its own stock or pay out a special dividend, all without compromising its own balance sheet integrity. That’s a big boon for the company’s shareholders.
All of this assumes that Bakers Hughes gets its break-up fee within a reasonable time frame. Given the financial pressures on Halliburton though, it would not be shocking if it tried to take some sort of legal measure to forestall the payment of that fee. Again $3.5 billion is a big number.
Investors in Baker Hughes and Halliburton over the medium-term should do reasonably well. The firms are still part of the triumvirate of premier OFS firms (along with Schlumberger), and while the outlook for oil prices remains bleak now, history suggests these things can shift quickly. After all, in 2013, very few people were talking about oil prices being headed for collapse.
None of that means that Halliburton and Baker Hughes shares won’t come under pressure – they probably will. But it does mean that shareholders should not reflexively panic. With this deal off the table and both Halliburton and Baker Hughes having new capacity for smaller deals and perhaps an appetite for the same thing, mid-sized OFS firms may become interesting acquisition targets.
For instance, Weatherford International and Franks International might both be attractive takeover targets for either Baker Hughes or Halliburton. Finally, it is possible that either Halliburton or Baker Hughes could find themselves the subject of interest from a larger non-competitor that seems to have an interest in entering the space; GE. Only time will tell of course
By Michael McDonald
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