If the deal were to break, we believe Halliburton would initially trade down, but less than 5%, while Baker Hughes would potentially fall to the low-$30s…
Baker Hughes: Given the employee turnover (one private-equity executive told us he believes the next group of NAM startups will be led by ex-Baker Hughes employees), the cannibalization of its equipment at the onset of the downturn, and the general disorder within the company, we believe standalone-Baker Hughes’ revenue growth and margin improvement would lag its peers when the upcycle resumes and likely means that Baker Hughes’ consensus estimates are stale and too high. We view a low to mid $30s break price as the most likely scenario. Halliburton and Baker Hughes were basically trading at par prior to the deal announcement.
Halliburton. The $3.5 billion termination fee Halliburton would have to pay to Baker Hughes equates to $2.65 per share on a tax-adjusted basis (assuming 35%). As such, we believe Halliburton shares would initially trade down if the deal were to break, but not to the magnitude of the termination fee (i.e., down less than 5%). The timing of the deal was not ideal and many shareholders have questioned the richness of the $19 per share cash component, as well as owning a company during an integration process that could very well last several years. Additionally, we believe improvements in Halliburton’s margins could outweigh the $3.5 billion fee. Recall, Halliburton continues to maintain its service delivery platform and infrastructure in excess of market needs ahead of the Baker Hughes transaction, incurring costs which Halliburton would have otherwise eliminated. Halliburton estimates its 3Q and 2Q NAM margins were 400 bps and 300-400 bps lower as a result, respectively… Incorporating this into our model, our trough NAM margins improve to 0% from (5.7%) and our 2018E EPS increases to $2.55 from $2.25. Applying the same 17.3x multiple and netting the $2.65 per share our theoretical PT would improve to $42 ($45 ex-breakup fee) from $39 currently. Additionally, we believe Halliburton’s international infrastructure also remains stretched relative to market needs, though the company has not quantified the margin effect, and that the disarray within Baker Hughes would allow Halliburton further market share opportunities, particularly in North America.
Shares of Halliburton have declined 0.9% to $33.71 at 11:06 a.m. today, while Baker Hughes has fallen 2.9% to $40.26.