Deals

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.

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

GE's shareholders should be breathing a sigh of relief this Friday. Baker Hughes's should be laughing.

General Electric Co. says it's in talks with oilfield equipment provider Baker Hughes Inc. regarding potential partnerships -- NOT a takeover as had been reported Thursday night by The Wall Street Journal. GE's stock rallied as much as 2.7 percent on Friday.

GE somehow managed to avoid the harsh criticism heaped on rival Siemens AG for its expensive takeover of Dresser-Rand Group Inc. just before oil prices plunged. But if you ask them, GE investors don't have many warm and fuzzy feelings about the company's expensive takeover of Lufkin Industries Inc., completed only about a year before oil prices began their precipitous decline. And shareholders certainly wouldn't be pleased to see the company paying top dollar yet again to expand an oilfield-services arm that has been a big drag on revenue and profit.

Meanwhile, it's hard to identify a more fortunate company in the energy sector today than Baker Hughes.

Two years ago, it looked like the sick man of the sector before getting a bid from rival Halliburton Co. that held investors' attention through 2015 and early 2016, even as the energy industry headed over a cliff in the background.

Today, Baker Hughes is the only one of the big three oilfield services firms to be worth more than it was back in November 2014, when Halliburton made its bid. The latter's $3.5 billion break-up fee after the deal collapsed has also left Baker Hughes with something of a rarity in this industry: a pristine balance sheet.

Hughes Laughing Now
Baker Hughes is the only one of the big three oilfield-services firms to be worth more than it was back before the Halliburton bid emerged
Source: Bloomberg
Note: Performance indexed to 100 on Nov. 12th, 2014, just before reports of a Halliburton bid for Baker Hughes emerged.

And now, GE's kinda-sorta merger interest has reignited takeover speculation around Baker Hughes's stock, which jumped as much as 7 percent on Friday morning.

Even without a full takeover, a GE partnership would be a major win for Baker Hughes.

For one thing, it fits neatly with the company's new asset-light strategy, announced back in May and reaffirmed with this week's blowout third-quarter results.

GE's business line complements Baker Hughes. The industrial giant brings sub-sea and equipment offerings as well as big-data capabilities that could enhance any combined services business. Outside of artificial lift -- technology that squeezes more oil to the surface -- there is little overlap to worry antitrust regulators. Indeed, if a deal did happen and some of those assets had to be sold, then Halliburton would be on the list of potential buyers (the M&A gods truly work in mysterious ways.)

What's more, as Ole Slorer at Morgan Stanley points out, there is some precedent in the sector for partnerships to eventually evolve into full buyouts. This was the case with Schlumberger Ltd. and Cameron International Corp., as well as Technip SA's merger with FMC Technologies Inc.

A League Worth Joining?
A look at some of the biggest oil and gas services deals attempted over the past few years.
Source: Bloomberg

GE's apparent reluctance to entertain a full bid right now is understandable. Assuming a 30 percent premium, Baker Hughes's price tag would be just shy of $30 billion -- not the highest it's ever traded, but also not far from it.

That price tag looks all the more expensive given what's happened to analysts' forecasts. GE would be offering about 21 times Baker Hughes's projected Ebitda for 2017. In comparison, Siemens offered about 14 times Dresser-Rand's forecast 2015 Ebitda at the time of that deal's announcement. And GE paid only about 11 times Lufkin's projected 2014 Ebitda.

Losing Altitude
Analysts have slashed their estimates for Baker Hughes' Ebitda as oil prices plunged.
Source: Bloomberg
Note: Consensus forecasts for 2016 Ebitda.

Baker Hughes at this premium would likely dilute GE's earnings per share near term, whether done with all cash or 50 percent stock. Synergies would have to be huge and convincing to sell it to investors. 

That said, GE needs to do something. There have been rumblings about whether the industrial giant is still too big for its own good, with the oil and gas business being one division investors perhaps wouldn't mind losing. CEO Jeff Immelt felt a need to call out the energy unit as a "core" GE business on the most recent earnings call.

So GE could do with either rounding it out or exiting it altogether. Partnering with Baker Hughes could tee up the possibility of actually doing both. 

First, demonstrate to skeptical investors there are potential synergies on offer with a pilot joint venture. Second, use that -- and any background recovery in energy markets -- to eventually launch a full merger. Third, spin off the combined business, with a suite of products and services rivaling industry leader Schlumberger, in terms of scope at least.

That's pure speculation, of course, though not outlandish. There's room here to make both GE and Baker Hughes shareholders happy.

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

To contact the authors of this story:
Liam Denning in New York at ldenning1@bloomberg.net
Brooke Sutherland in New York at bsutherland7@bloomberg.net

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