Halliburton Isn't Petrified

But it's straining its balance sheet to position for an oil rebound.
At Closing, June 20st
45.71 USD

Both Halliburton and Baker Hughes performed their own particular renditions of "I Will Survive" on Tuesday morning. But while Baker Hughes opted for a low-key, jazzy approach, Halliburton's was more of a full-throated, late-night karaoke effort.

Baker Hughes glided over the collapse of the companies' proposed merger, expressing disappointment but essentially saying what's done is done. Having been the intended target and now walking away with a $3.5 billion break fee, the company can afford to be philosophical.

Halliburton, which led the deal and cut that $3.5 billion check, was more defensive. It reiterated its belief that U.S. and European regulators' objections to the deal were wrong. It also suggested the deal was a victim of a broader shift in the Department of Justice's approach to large mergers, regardless of industry.

A Long Engagement

Indexed price performance

Source: Bloomberg

Halliburton may be right. On the other hand, it also acknowledged that oil prices had collapsed since the deal was announced in November 2014, making it harder to dispose of assets and eroding synergies. It also made that $19 per share cash component of the offer to Baker Hughes stick out like the sorest of thumbs. And, as French oil major Total said in public, struggling exploration and production companies had legitimate concerns about a deal creating duopolies in certain oil-field service lines even as their own losses mounted.

So the simpler explanation is that this deal, born partly out of a desire to deal with lower oil prices, was also ultimately killed by them. More relevant than a post-mortem, though, is what comes next.

On this front, Baker Hughes showed defensiveness of a different, and more useful, variety. Recognizing the severity of this downturn, the company isn't just taking out the excess cost it had kept on during the failed merger process. Rather, it is shifting strategy, no longer trying to be everything, everywhere.

In the U.S., for example, Baker Hughes will focus efforts on two basins that account for almost half the active rigs and a third of drilled but uncompleted wells. This plays to the company's strengths and also mirrors the approach of its E&P client base: Focus on what pays now and what might come back first when oil prices rise. Overseas, Baker Hughes aims to partner with local services firms, leveraging its brand and technology through sales channels it doesn't have to fund.

All of this suggests that there's a decent chance Baker Hughes will deliver more than its initial estimate of $500 million of annual cost savings now that the deal is off.

Importantly, it also suggests Baker Hughes isn't counting on a rebound in oil prices and drilling. Indeed, on Tuesday's call, chief executive Martin Craighead's summary of the market environment was a study in caveats, with "one potential scenario" being that "oil markets could move back into some kind of balance by the end of 2016." Or, you know, not, if factors like Iranian production swing the wrong way.

Halliburton struck a more bullish pose. It didn't say the oil market was back to being balanced -- good job, too, with crude falling on Tuesday and taking the stock down almost 5 percent with it.

Still, Halliburton reiterated that it thinks the U.S. rig count will bottom out this quarter. And chief executive David Lesar added that the recovery in E&P activity will be sharp:

When this thing snaps back it's going to snap back hard.

Halliburton is maintaining a posture to match. In contrast to Baker Hughes, Halliburton thinks it's imperative to keep a presence in all basins across the U.S. in order to have "scope and scale."

So while Halliburton aims to cut $1 billion from annual costs, it isn't hunkering down -- despite its rising leverage. Halliburton's break-fee payment means handing over to Baker Hughes virtually all the $3.83 billion of free cash flow it made over the past five years, with all that this entails for the balance sheet.

The Aftermath

Halliburton's ratio of net debt to capitalization

Source: Bloomberg, the company

Note: 1Q2016 is pro-forma for payment of $3.5 billion break fee.

Even so, when asked about its priorities for cash flow, delevering didn't figure in Halliburton's response. Instead, it wants to focus on organic expansion, bolt-on acquisitions and share buybacks, in that order.

Halliburton's leverage is nowhere near as high as that of smaller rival Weatherford, and it has $6.6 billion of liquidity available, including its $3 billion revolver. So it has some scope for a more aggressive approach -- provided the oil market plays ball. And Halliburton may feel that, with Baker Hughes announcing a $1.5 billion buyback program right off the bat, it needs to hold out the prospect of a similar sweetener to keep investors on board. Baker Hughes, of course, starts from a position of having net cash rather than a spike in net debt.

And this is the most curious distinction between the two companies now that they are back to being full-on rivals. Baker Hughes is the one with the ultra-conservative balance sheet and yet also the more cautious outlook necessitating pulling back in some areas. In contrast, despite having just blown $3.5 billion on a deal gone wrong, Halliburton is pressing forward to capitalize on the eventual recovery in drilling, letting its balance sheet take the strain in the meantime.

The oil sector has a tendency to favor the bold. With the outlook as uncertain as it is now, though, there's no shame in taking Baker Hughes' more measured approach to surviving.

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

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