McDermott-CB&I

Stamp This Energy Deal Cheap for a Reason

The catalyst for McDermott's CB&I bid is clearly price, but execution will be tricky.
Corrected
Photographer: Mark Wilson/Getty Images
MCDERMOTT INTL INC
+0.12
At Closing, April 24th
7.12 USD

McDermott International Inc.'s bid for fellow energy-infrastructure firm Chicago Bridge & Iron Co. is hardly a knockout punch, but this is still the best outcome for the target company. 

McDermott announced an all-stock transaction late Monday that values CB&I at roughly $18 a share, based on the acquirer's closing price last week. That works out to a combined enterprise value of about $6 billion. There's essentially no premium involved, and the offer is a steep discount to where CB&I traded this time last year, despite touted annual synergies of $250 million.

But all of this is for good reason. CB&I is on the ropes. The company announced a $548 million write-down in August due to cost overruns on several projects. The stock, stumbling already, hit the canvas:

Bridge To Nowhere

Chicago Bridge & Iron has had a terrible 2017

Source: Bloomberg

To repair its balance sheet, CB&I eliminated its dividend and put its engineered products operations and its technology platform -- a higher-margin crown jewel -- up for sale. 

By selling the whole company instead, CB&I shareholders will get higher-valued McDermott paper and keep a stake in that important technology business, with the chance to benefit from a cyclical recovery in general. Both McDermott and CB&I focus on fixed-price contracts, which tend to be riskier because there's less flexibility if costs spiral out of control as they did this past year at CB&I.

So those types of challenges will still exist. However, the greater scale and geographic diversification posed by the merger may offset some of the volatility. CB&I gets more than two-thirds of its revenue from the U.S. and focuses predominantly on onshore energy projects, while McDermott's sales base is more spread out, with the biggest contributions coming from Australia, Saudi Arabia and Qatar; and it caters to offshore clients. We've seen similar deals in the energy services sector, such as Technip SA's combination with FMC Technologies Inc.

The catalyst is clearly price, with the exchange ratio of 2.47221 McDermott share for each of the target's shares essentially where they've traded since CB&I's stock collapsed this summer:

Bridging The Gap

CB&I is selling for roughly the relative price at which it has been trading since the summer

Source: Bloomberg

Even though they're getting CB&I on the cheap, McDermott's shareholders have a right to be a little wary about this transaction (the stock plunged 11 percent on Tuesday morning). The companies have said they're targeting $250 million of cost savings, on top of the $100 million in expenses CB&I was already aiming to cut internally. If achieved, then after initial costs, and taxed and discounted at 10 percent, the net present value of the synergies would cover about 40 percent of McDermott's equity check.

To put the synergies figure in perspective, though, CB&I's entire operating expenses (not cost of goods sold) in the year through September were $267 million. And of that targeted $250 million, a portion will  come from a 16 percent reduction in the combined companies' "other business related costs" in addition to the standard general and administrative expense streamlining, supply-chain savings and operations optimization. Pressed about that on a call with analysts, McDermott CFO Stuart Spence said "other business related costs" referred to "certain policies, certain procedures and processes, and also kind of where we overall want to drive in efficiency in execution." Well, thank you for that clarity. McDermott has said it feels comfortable with CB&I's backlog and has a handle on problem projects. Then again, CB&I has said that before as well.

One clear beneficiary from the deal is Greenhill & Co. The advisory firm's deal drought had gotten so dire it resorted to a plan to buoy its stock that involved taking on significant debt to fund buybacks. This transaction won't be a silver bullet -- Greenhill will split an estimated $30 million to $40 million in fees with McDermott's four other advisers, according to Freeman Consulting Services -- but every deal helps as rainmakers head for the exits.

Paid all in stock, and with its lack of premium and twin rationales of diversification and cost-cutting, this has all the hallmarks of a classic pooling of assets at a time when the entire energy-services sector is suffering -- particularly the bits of it that construct mega-projects or work in the moribund offshore business. The outlook on oil prices is too murky to say this deal marks a bottom for the sector. It's just what happens when things are this tough.

--With assistance from Gadfly's Gillian Tan

(The ninth paragraph of this story was corrected to show that targeted reductions of "other business related costs" are a percentage of combined company expenses, not of total synergies.)
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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

    To contact the editor responsible for this story:
    Beth Williams at bewilliams@bloomberg.net

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