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Baker Hughes shareholders do maths over GE deal

General Electric's plan to merge its oil and gas division with Baker Hughes should be a boon for the oilfield services company amid testing times for the sector. But Baker Hughes shareholders may need some convincing

While global oil and gas M&A activity remains lacklustre one of the world's largest conglomerates is bucking the trend by planning to merge its oil and gas division with oilfield services provider Baker Hughes.

If the $32bn deal, which is expected to close next year, goes ahead General Electric (GE) will take a 62.5% stake in Baker Hughes, paying $7.4bn to fund a one-time cash dividend of $17.50 per share to the oilfield services firm's existing shareholders.

Baker Hughes, which will retain the remaining 37.5% share, will become the world's second largest oilfield equipment and services firm. Schlumberger remains the largest, in terms of market capitalisation, while Halliburton will slip into third place.

Superficially the deal looks a boon for Baker Hughes at a time when the sector has been hit hard by the crude price crash and cuts to upstream capital spending.

Jeff Immelt, GE's chief executive, said the deal will give GE investors "substantial synergies and an improved competitive position", adding around $0.04 to GE's earnings per share in 2018, which will then rise to $0.08 by 2020.

GE expects the new company will have combined revenue of $32bn and synergies of $1.6bn by 2020.

"While this is primarily driven by cost out, we believe that the new company is positioned for growth as the industry rebounds," GE said. "There is a large pool of synergies that will improve operating margins and drive organic growth. The "New Baker Hughes has a strong balance sheet."

The old Baker Hughes, however, did not. In 2015 the company booked a pre-tax loss of $2.6bn, compared to a $2.6bn profit in 2014.

Its activities in North America incurred a pre-tax loss of $0.687bn last year compared to a pre-tax profit of $1.47bn in 2014 - a fall of almost 150%. The company said its North America division had been hit particularly hard by the sharp decline in drilling activity and "an increasingly unfavourable pricing environment".

Oilfield services companies have been hit hard by the near 50% drop in crude prices over the past two years, which has curbed upstream spending and slashed rig numbers.

Between 2015 and the end of October this year, 109 service companies in North America alone had been pushed into bankruptcy, according to law firm Haynes and Boone. Their aggregate debt was almost $18.7bn, the firm said.

There has been some uptick in US drilling activity recently which has been a relief for oilfield-services companies buckling under the pressure of industry capital spending cuts. But a full industry recovery will not be swift.

So the GE deal should have been good news for Baker Hughes but shareholders questioned it.

In the hours after the deal was announced Baker Hughes' share price plunged, from around $59.12 per share before the deal was announced to around $55.40. In the following days it fell further, down to $54.46 on 2 November.

Brad Handler, an equity analyst at investment bank Jefferies, said Baker Hughes shareholders felt the company had been sold short when the oilfield services sector was on the cusp of a recovery.

"Shareholders did some maths on the day of the deal and concluded that there wasn't much value being created except for the synergies being created over the long-term," Handler said. "GE has bought companies recently that have subsequently lost value over the following years. Investors were also optimistic that with the oil price recovery there will be an uptick in oilfield services activity. So it dilutes Baker Hughes' exposure to that recovery."

Handler added that Baker Hughes investors were also hoping that GE would buy the oilfield services company outright, rather than the 62.5% share it has agreed to purchase. The fact that GE has only bought a stake, not the entire company, adds long-term risk to Baker Hughes' share price, he said.

"For GE shareholders the cyclical nature of the oil and gas business (price-wise) was a concern. So it gives GE shareholders a choice: to hold onto Baker Hughes and retain its interest in energy or to let it go later on," Handler said. "GE shareholders get exposure to the recovery if they want it and future cost synergies. But it's not obvious why it is better as a combined entity. We're not sure yet what it means for Baker Hughes as there are questions around how well GE has run its oil and gas business."

Zachs, an investment research firm, said the deal was an attempt by GE to offset falling sales from its Oil & Gas division. Revenue from GE's Oil & Gas division fell by a quarter in Q3 2016, compared to a year earlier, down to $2.96bn.

"Experts widely believed that the GE Oil & Gas business lacked product breadth and was losing market share in a few key product lines, leading to increased risk of asset erosion," Zachs said. "The strategic deal, therefore, fortifies the beleaguered business to ramp up its operations to fend off competition from rivals like Schlumberger Limited - and Halliburton Company".

The firm added that it remained "impressed by the opportunistic deal" and expects it to be mutually beneficial for both companies over the long term.

Baker Hughes declined to comment on whether its shareholders were happy with the deal offered, saying in a statement that it would benefit all stakeholders.

The company's share price has since recovered to close to its pre-deal value, trading at just under $59 per share at the beginning of November.

"Baker Hughes has been on the road trying to convince investors that the synergies make sense," Handler said. "That the deal will provide a stability of revenue flow. That's something investors don't understand at the moment."

Unlike Halliburton's failed bid to buy Baker Hughes, which fell apart earlier this year, GE's offer is not likely to come up against any objections from regulators. But it still needs approval from Baker Hughes shareholders before it can close next year.

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