National Oilwell Builds a Drilling Powerhouse

The company's deal to buy Grant Prideco makes it a formidable competitorbut it may face price battles in its new drill-bit market

National Oilwell Varco (NOV) said on Dec. 17 that it will acquire Grant Prideco (GRP) in a stock and cash deal valued at roughly $7.5 billion.

The Houston (Tex.) provider of oil and natural gas rigs and other drilling equipment and services will pay Grant Prideco shareholders $23.20 in cash, plus 0.4498 shares of National Oilwell Varco for each share of Grant Prideco. The deal offers Grant Prideco shareholders a 22% premium to $47.46, the price at which shares closed on Nov. 14.

On Monday, Grant Prideco shares were trading 13.2% higher at $53.71, while shares of National Oilwell were down 9.4% at $70.08.

The transaction isn't expected to disrupt Grant Prideco's pending $800 million sale of its tubular businesses to Vallourec S.A., the companies said.

The companies expect the deal to bolster National Oilwell's profits and cash flow per share next year on a pro-forma, full-year basis, figuring an estimated cost savings of $40 million.

This transaction has been much talked about over the past several years and it's an ideal fit for National Oilwell, said Thaddeus Vayda, an equity analyst at Stifel Nicolaus & Co. in Baltimore. The firm has buy ratings on both National Oilwell and Grant Prideco. (Stifel, Nicolaus expects to receive or intends to seek compensation for investment banking services from Grant Prideco within the next three months.)

"It extends their franchise strongly below the surface of the earth and the surface of the water to drill bits and pipe," he said.

In gaining products that are complementary and will allow it to make the connection between drill bits and downhole equipment, "there are very few components left that National Oilwell won't provide to drill a well," said Roger Read, an equity analyst at Natexis Bleichroeder in Houston.

In addition, no single competitor currently provides quite as complete an array of drilling equipment as National Oilwell will after the acquisition closes, Read said. The firm has a buy rating on Grant Prideco and a hold on National Oilwell. (Natexis managed or co-managed a public offering of securities for Grant Prideco within the past 12 months.)

Besides the 22% premium they are getting, the deal is good for Grant Prideco investors because it will let them continue to participate in the growth of the oilfield equipment and services industry, by owning shares of National Oilwell, both analysts said.

Vayda said he considers the combination of cash and stock that National Oilwell is offering a fair valuation at $58 per share, only slightly below Stifel Nicolaus' valuation of Grant Prideco at $60 per share.

This year, Grant Prideco shareholders have weathered lackluster growth in profits relative to the past few years due to stabilization in the North American drilling market amid a slowdown in drill pipe orders, said Vayda. Grant Prideco would have had to look toward international markets for continued growth, he added.

For Michael McShane, Grant Prideco's chairman, president and chief executive, who Vayda calls one of the most competent managers in the industry, to be willing to step aside, he had to be convinced of the merits of the combination at this time, Vayda said.

The complementary nature of the two companies' separate businesses suggests they shouldn't face any resistance from regulators due to antitrust concerns, Read said. In a preliminary research note on Dec. 17, Bank of America Equity Research said it didn't see any other logical bidders for Grant Prideco. (Banc of America Securities does investment banking with Grant Prideco and is affiliated with a specialist at the New York Stock Exchange that makes a market in the securities of both companies.)

But the lack of overlap also means there won't be any significant cost savings accruing to National Oilwell, he said. The projected $40 million in consolidation cost savings will be almost exclusively corporate-related, based on eliminating some overhead expenses and salaries for some of Grant Prideco's top officers.

While the drill bit business fits neatly into National Oilwell's portfolio of assets, it will require the company to take on the battle to secure better pricing for these products, which tend to not get credit for the advanced technology embedded in them, Vayda said.

Grant Prideco is the third largest manufacturer of drill bits, behind Baker Hughes Inc. (BHI) and Smith International (SII), and historically oilfield service operators have played these producers off each other in order to get lower prices, he said.

Unlike some other parts of the energy industry, where smaller players are at a disadvantage to companies of larger size and ability to take on bigger projects, very small companies in the contract drilling marketplace have managed to do quite well, particularly if they are focused on offshore projects, Vayda said.

He said it's also one more example of the "fairly prudent strategic consolidation" that has occurred at this stage in the oil and gas drilling cycle.

"Thus far, we haven't seen transactions that are grossly overvalued," he said. Instead, they have tended to be clearly complementary acquisitions, he added.

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