Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

One of the most interesting prospects in the energy sector right now is a company that just reported a huge loss, is under scrutiny by the Department of Justice, and kicked off its quarterly results announcement with this:

During the quarter, the industry faced another precipitous decline in activity, exceeding even the most pessimistic predictions.

This, ladies and gentlemen, is Baker Hughes.

The oilfield services giant turned in a predictably bad set of numbers on Wednesday. It isn't alone in that respect; all the services companies are suffering as exploration and production companies scale back and demand discounts amid low oil prices. Announcements of job cuts in the services sector have become depressingly familiar.

What sets Baker Hughes apart, though, is that it still has quite a bit of cutting to do -- and a potential windfall in its near future -- courtesy of the looming likely collapse of Halliburton's takeover bid. And despite the stock having jumped 18 percent since the DoJ sued to block the deal, Baker Hughes still looks cheap relative to its peers.

So Sue Me
Baker Hughes' stock is up 18 percent since the DoJ filed a lawsuit against its merger with Halliburton
Source: Bloomberg
Note: Indexed performance.

Baker Hughes still trades at a discount to its peers in terms of its price-to-book multiple. At 1.33 times, it even trails behind Weatherford, which is laboring under a mountain  of debt.

Unloved
Baker Hughes' discount to its peer group on average price-to-book multiple
Source: Bloomberg
Note: Peer-group average for Schlumberger, Halliburton and Weatherford, weighted by market capitalization.

I wrote a few weeks ago about how the $3.5 billion break-up fee that Halliburton will probably have to pay Baker Hughes turns the company from looking relatively expensive in terms of Ebitda multiples to looking pretty cheap. The adjustment took its enterprise value back then from 10.8 times 2017 Ebitda down to 9 times. Halliburton's was, in contrast, adjusted up from 8.9 times to 9.7 times. Schlumberger and Weatherford, meanwhile, were trading at 11.3 times and 10.5 times, respectively.

Yet even though Baker Hughes has jumped since then, its relative positioning may actually look even better now.

The reason boils down to this line in Wednesday's earnings release:

Although we have taken significant actions to manage our cost structure during the downturn, we are retaining costs in our operating profit margins in compliance with the merger agreement.

In plain English, Baker Hughes has held off from carrying out some restructuring on the basis that a more radical overhaul was due to come once the merger closed. If the deal collapses, then it will likely announce a plan of its own to cut costs. Say it manages to save 3 percentage points of revenue. On that basis, adjusting the current consensus forecasts for 2017, Baker Hughes' Ebitda would be almost $2.1 billion next year.

You can see what this, plus the $3.5 billion of new cash, does to its pro forma multiple now (to be fair, Halliburton has also been assigned a 3 percentage-point margin bump, assuming it was also holding back on some restructuring).

Shake 'n Baker
Baker Hughes' enterprise value to Ebitda multiple for 2017 drops significantly when adjusted for the break-up fee and potential cost cuts
Source: Bloomberg, Bloomberg Gadfly analysis
Note: Assumes $3.5 billion cash transfer from Halliburton to Baker Hughes and margin gain of 3 percentage points for each.

Baker Hughes' adjusted discount to Halliburton is now 12 percent, versus 7 percent a few weeks ago; its pro-forma discount to Schlumberger has widened from 20 percent to 35 percent.

Might analysts have already baked in a potential margin increase? Possibly, but if they have, it isn't showing up in the consensus figures.

No Benefit of the Doubt Here
Consensus forecast for Baker Hughes' 2017 Ebitda
Source: Bloomberg

Indeed, the corresponding move in revenue estimates implies that the expectation for Baker Hughes' Ebitda margin in 2017 has actually decreased from 14.6 percent at the start of the month to 14.1 percent now, using data compiled by Bloomberg.

Of course, the deal may yet come through. If it did, then Baker Hughes' shareholders would be looking at an almost instantaneous gain of another 40 percent based on the current implied offer of $65 a share. If that sounds miraculous, it's because that is what would be needed to save the merger at this point. Fortunately, Baker Hughes' stock still looks better than its peers without one.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net