Key Energy in Play With Baker Hughes Chasing Shale Oil: Real M&A

Baker Hughes Inc. (BHI) is looking at deals as it tries to extract bigger profits from the boom in U.S. shale-oil exploration. That may put Key Energy Services Inc. (KEG) and Lufkin Industries Inc. (LUFK) on its wish list.

Baker Hughes, which provides drilling services to oil and gas companies, is seeking opportunities to make acquisitions, Andy O’Donnell, its president for the western hemisphere, said this week. After spending $7.1 billion on BJ Services Co. last year to gain a pressure-pumping business that helps drillers unlock oil trapped in shale, Key Energy, which hauls the fluids used in hydraulic fracturing, and Lufkin, a maker of pumps used to extend well production, may now make sense for Baker Hughes, Cambiar Investors LLC and Tudor Pickering Holt & Co. said.

With oil prices eclipsing $100 a barrel, oilfield-services suppliers are vying to help energy companies tap unconventional assets as the average cost for finding and developing the fuel for the largest U.S. producers surged more than sixfold in the past decade, according to data compiled by Bloomberg. Among U.S. oilfield-services companies between $1 billion and $5 billion in market value, analysts project Key Energy and Lufkin will boost earnings by the most next year to records, the data show.

“Strategically it definitely would make a lot of sense” to buy Key Energy, Tim Beranek, a Denver-based money manager who specializes in energy companies at Cambiar, which oversees $8 billion, said in a telephone interview. “Oil services stocks are very inexpensive on their earnings power assuming that the oil price stays in the $90 to $100 range.”

Cambiar owns shares of Baker Hughes, Key Energy and Lufkin.

Shopping List

Today, Lukfin jumped 2.5 percent to $70.92 as of 10:27 a.m. in New York, the biggest advance among energy stocks in the Standard & Poor’s SmallCap 600 Index, which fell 0.4 percent. Shares of Key Energy rose 0.3 percent.

Gary Russell, a spokesman at Houston-based Key Energy, didn’t respond to a telephone call or e-mail requesting comment. Christopher Boone, chief financial officer at Lufkin, Texas- based Lufkin, declined to comment.

Teresa Wong, spokeswoman at Baker Hughes in Houston, said it doesn’t comment on rumors or speculation.

“We’re always going to look at opportunities and have things we buy,” O’Donnell said at a conference in Miami on Nov. 15, adding it wasn’t clear what Baker Hughes would need to acquire right now. “There’ll be dynamics that change in the market as we go forward that there’ll be things that you have to bring into the portfolio.”

Hydraulic Fracturing

Baker Hughes is the world’s third-largest provider of services, tools and technology to oil and natural gas producers, competing with Halliburton Co. (HAL) and Schlumberger Ltd. (SLB) Its equipment and services are used to drill wells and open them so their owners can begin producing oil and gas. Baker Hughes is also hired to boost production from older fields.

Baker Hughes acquired BJ Services, which was the third- largest provider of pressure-pumping services at the time, in a cash-and-stock deal to compete for the larger integrated projects by adding a hydraulic-fracturing business to its product line, Chad Deaton, the company’s chief executive officer, said in a statement when the deal was announced in August 2009.

Known as “fracking” in the oil industry, the technique is used by producers primarily when drilling horizontally through oil-bearing rock to fracture the formation by injecting a mixture of water, sand and other chemicals to release oil.

Demand for fracking has increased as rising oil prices makes it more affordable to explore on land than under water and deposits were discovered in parts of the U.S., including the Eagle Ford in southern Texas, the Bakken shale in North Dakota and the Permian Basin in western Texas.

Slurry

The number of horizontal rigs active in the U.S. has more than tripled to 1,152 since the end of 2006, as the number of vertical rigs fell 36 percent in the same period to 633, data compiled by Baker Hughes and Bloomberg show.

Key Energy would be a good fit because its fluid transport services go “hand in hand” with Baker Hughes’s pressure- pumping business, according to Cambiar’s Beranek.

Key Energy’s trucks carry the millions of gallons of slurry, or the mix of water, sand and chemicals in fracking. The company also disposes of and stores the fluid for reuse, and makes the coil tubing used to clean out wells before production begins.

Wells in the Marcellus shale, located in the northeastern part of the U.S., use about 3 million to 7 million gallons of water, according to the Marcellus Center for Outreach and Research at Penn State University, citing Chesapeake Energy Corp.

Artificial Lift

Per-share profit at Key Energy may rise by 71 percent to $1.62 next year, more than any other oilfield-services company of similar size apart from Lufkin, analysts’ estimates compiled by Bloomberg show. The $2.27 billion company is now valued at 9.3 times estimated earnings, about two-thirds less than its multiple based on profit reported in the past 12 months.

Key Energy would help Baker Hughes “control all aspects of the project,” Brian Uhlmer, a Houston-based analyst at Global Hunter Securities LLC, said in a telephone interview. “The big issue now around the wells is water. Although it’s not a high- tech business, it can actually be very accretive when you talk about total project management.”

Lufkin’s so-called pump jacks, used to pump oil out of the ground when an older well loses its natural pressure, would also help Baker Hughes expand its range of services, according to Joe Hill, a Houston-based analyst at Tudor Pickering.

While Baker Hughes makes a competing pump called an electric submersible pump, buying Lufkin would give it a foothold in the part of the so-called artificial lift market that still accounts for 40 percent of sales, Global Hunter said.

‘Fleshed Out’

Analysts estimate earnings at Lufkin, which has a market value of $2.1 billion, will reach $4.26 a share next year for an 80 percent increase from this year’s estimate, data compiled by Bloomberg show. That’s more than double the median profit increase for comparable companies in the industry.

Baker Hughes has 20 percent of the market for artificial lift services, trailing only Weatherford International Ltd., according to data compiled by Spears & Associates Inc.

“It extends the Baker Hughes product offering without overlapping anything that Baker Hughes does,” said Richard Spears, vice president at Spears & Associates. “That would fit with what they currently do.”

Luke Lemoine, an analyst at Capital One Southcoast Inc. in New Orleans, says Baker Hughes doesn’t need any more major acquisitions to compete in the oilfield-services industry.

Baker Hughes is “pretty well fleshed out,” he said in a telephone interview. “Nothing on a transformative level needs to be done.”

Still, Cambiar’s Beranek says Baker Hughes can profit from doing deals now, especially as record earnings at Key Energy and Lufkin next year push down projected valuations and crude oil trades at more than $100 per barrel.

“With this boom, there’s a big demand for services and there’s a shortage in some cases,” Philip Weiss, an analyst at Argus Research in New York, said in a telephone interview. “This is where there’s really a lot of potential for the service companies in terms of future profitability.”

To contact the reporters on this story: Tara Lachapelle in New York at tlachapelle@bloomberg.net; David Wethe in Houston at dwethe@bloomberg.net

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net; Susan Warren at susanwarren@bloomberg.net.

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