Oil Services ‘Ugly’ Second Quarter Seen as Prompting Mergers

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Deals among oil services companies trying to survive a collapse in crude prices are expected to pick up in the second half of the year as profits hit a low point.

Demand for drilling, hydraulic fracturing and logistics services provided by companies such as Halliburton Co. and Schlumberger Ltd. have been falling steadily as oil prices collapsed to below $44 a barrel in March. The three months ending June 30 will represent peak pain for those businesses.

That will drive a reckoning among smaller companies with weaker balance sheets that may not be able to sustain operations on their own. Merging, then, becomes a matter of survival, said Jim Rebello, head of energy investment banking for financial advisers Duff & Phelps Corp.

“The service-side M&A activity will accelerate as we go through the remainder of the year,” he said in an interview. “There’s too much capacity. We don’t think every company will make it through this down cycle.”

Companies that have been reluctant to accept low-ball offers from suitors may find salvation in stock-for-stock mergers and acquisitions that benefit shareholders for both sides, Rebello said.

Services companies have been the hardest hit in the energy industry. The market crash compelled drastic cost-cutting among their customers, amounting to more than $100 billion. The number of drilling rigs active in North America has fallen 59 percent from last year’s November high of 2,363, according to Baker Hughes Inc.

Deals Stalled

The rig count has fallen lower every week since the middle of January.

After Halliburton shocked the industry by agreeing to pay $34.6 billion for rival Baker Hughes in November, consolidation stalled as oil companies concentrated on coping with the downturn. More than 120,000 jobs were cut worldwide since June. Prices for fracking services are estimated to be down 35 percent this year, according to PacWest, a unit of IHS Inc.

There’s more “ugly” to come, said Bob Gray, an energy attorney at Mayer Brown in Houston, said in a phone interview.

“We have not seen the worst yet,” Gray said. “Everybody’s battening down the hatches. It’s bloody as far as letting people go, but they’re still working off their backlogs.”

Market Thaw

The “frozen” M&A market for service companies could start to thaw after Halliburton and Baker Hughes sell their overlapping assets for antitrust approval of their merger, James West, analyst at Evercore ISI in New York, wrote Thursday in a note to investors. The assets are expected to fetch bids from a variety of interested companies.

“All of the companies have likely convinced themselves that acquisitions are in their best interests,” West wrote. “This could lead to a solid M&A cycle.”

Ole Slorer, an analyst at Morgan Stanley, issued a note to investors last month calling the bottom in the oilfield services market. Prior cycles suggest the U.S. rig count would bottom around mid-year, according to Slorer’s note.

Schlumberger, the world’s largest oilfield-services company and considered the bellwether among contractors, is expected to see a 25 percent drop in second-quarter adjusted earnings from the first three months of the year, according to data compiled by Bloomberg. Basic Energy Services Inc., a smaller competitor, is expected to have a wider quarterly loss, after last month reporting its worst results in six years.

‘Smaller Guys’

With half the business and cash flow, struggling companies can combine to provide enough capital to make it through the down cycle, Rebello said. “You really only need one of those companies’ corporate infrastructures to support that combined business,” he said.

If there are mergers, they’ll be limited to transactions among smaller companies, said Stephen Trauber, global head of energy investment banking at Citigroup Inc. in Houston. “The big guys don’t need anything from the smaller guys,” he said.

Half of the 41 fracking companies operating in the U.S. will be dead or sold by year-end because of slashed spending by oil companies, an executive for Weatherford International Plc said last month. There were 61 fracking service providers in the U.S., the world’s largest market, at the start of last year.

“There is buyer interest in the sector,” Doug Meier, energy deals leader at PricewaterhouseCoopers LLP in Houston, said in a phone interview. “From a seller’s perspective, it’s coming to grips with the realization of where the market is versus where the market was.”

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