On Sunday, energy exploration industry leaders Halliburton Company (HAL) and Baker Hughes Incorporated (BHI) called off their merger deal which was valued at approximately $28 billion. Halliburton first announced plans to acquire Baker Hughes in November 2014, however, the duo struggled to get the green light from antitrust regulators in multiple countries including the US and EU.
Broken Deal; Halliburton Company and Baker Hughes Announce Termination of Planned Merger. Less than a month after the U.S. Department of Justice sued Halliburton to block its proposed acquisition of Baker Hughes (BHI, Buy), the two companies have announced the termination of the November 2014 merger agreement, effective April 30, 2016. We view today’s announcement as expected. Halliburton also announced that it will pay BHI the $3.5 billion termination fee by Wednesday, May 4, which we view as a positive for BHI and a slight negative for HAL. There was some thought that HAL was likely to fight the termination payment, but today’s announcement quashes any such theories.
In the short term, Baker expects to take immediate action to remove costs that were retained in compliance with the former merger agreement. Beyond those previously disclosed costs, the company will make higher-level structural changes to reduce cost and increase efficiency to keep the company flexible during the last stages of the downturn. This first phase of cost cutting is projected to yield $500 million annually in cost savings by the end of 2016.
We view this news as a confirmation of what we and the Street have expected. We think it was the correct decision for both companies given the high cost of fighting seemingly insurmountable government objections. We would buy both Halliburton [HAL, $41.31, Outperform] and Baker Hughes [BHI, $48.36, Outperform] should either stock underperform tomorrow.
The announcement was widely expected by investors and we don’t think the news changes the thought process for owning Halliburton Company. We continue to like HAL for its exposure to an eventual NAM recovery, dominant market positions, and technology based service offerings.
Post deal break, BHI gets $3.5bn cash from HAL and nets 500 bps of operating margin improvement, as it will no longer be encumbered by the merger agreement. According to the bulls, the dissolution of the merger would then set in motion a series of events that could include market share gains, acquisitions, etc
The strategic effort was primarily aimed at gaining electrical submersible pumps and production chemicals, two business that HAL could not develop organically as quickly as it needed to compete primarily in international mature field asset management work. Near term and in the North American market, those businesses are not as critical and HAL remains one of the greatest beneficiaries of the coming recovery in that market. Longer term, it could be an issue in the growth internationally
The termination outcome was the best possible result for HAL given the likely challenges in achieving targeted synergies due to the protracted nature of the downturn, and the reality that the $3.5bn breakup fee payment was already baked into the shares, in our view.
HAL will pay the $3.5 bil by May 4, 2016 and expects the payment to be tax deductible (implying $4.08 pre-tax per share, $2.65 post-tax per share). HAL believes they are carrying 300-400bps in additional overhead. For BHI, the proceeds will be used to buyback $1.5 bil stock (7% of shares outstanding) and to pay down $1 bil in debt.
We believe that BHI has a clear plan for restructuring of operations in place pending the deal failing. It clearly delineated the carrying costs of the HAL deal which indicates that it is aware of the underperforming units that need rapid changes. We would expect BHI to present the plan to its investors promptly, including a clear path forward for margin improvements.
See the following visualizations to compare the Halliburton/Baker Hughes merger to the largest announced mergers in Q1 2016, as well as to highlight a number of relevant figures regarding Halliburton and Baker Hughes.
Halliburton vs. Baker Hughes 2-Year Returns
Halliburton & Baker Hughes Merger Deal Compared