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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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How To Play A Potential Collapse In The HAL/BHI Merger

The Baker Hughes/Halliburton merger saga continues to drag on. Jefferies recently downgraded the probability of the deal being completed from 85 percent to 67 percent, indicating concern over the antitrust review being run by the U.S. government. Haliburton will have to sell roughly $7.5 billion in assets to get regulatory approval for the deal. More importantly though, it will have to sell those assets to a single buyer.

Given that price tag, conglomerates General Electric and Siemens look like the most likely buyers. There is always the possibility of a dark horse bidder like Berkshire Hathaway or Blackstone, but that would be an unusual move for either party. Competitor Schlumberger is off the table as a buyer given the competitive concerns that such a sale would create both from the point of view of the Department of Justice and Halliburton itself. Related: Can Russia Withstand Saudi Onslaught In The European Oil Market?

Haliburton is still strongly backing the merger and there is a good chance the deal will still go through. Yet, if the deal does fall through, shareholders can still profit. Baker Hughes’ stock in particular would be hammered if the deal falls apart and that creates an opportunity for investors. The stock of BHI is trading in the low $50s currently, but would likely fall to at least $45 and perhaps $40 if the merger with HAL ends up imploding. Investors can play this possibility (or hedge against a merger collapse if they own BHI stock) by owning puts in BHI at $40 or $45. These ‘out of the money’ puts are reasonably priced and long-dated versions of the puts would increase dramatically in value were the merger cancelled.

SLB and HAL both might make attractive short targets as well in the event of a merger breakup, but neither has nearly as much risk exposure as BHI does. HAL would certainly suffer given the multi-billion dollar break-up fee that it would have to pay to Baker Hughes, but this risk is probably already impounded into the depressed stock price of HAL. Similarly, Schlumberger shareholders would probably have mixed feelings about a deal collapse as well, since it would mean a less powerful competitor facing SLB, but also less opportunity for oligopolistic profits in the industry. In fact, Schlumberger has its own merger to worry about completing. Related: IEA Sees No Oil Price Rebound For Years

In late August, SLB agreed to buy Cameron International in a deal worth roughly $15 billion. In comparison to the BHI-HAL tie-up, SLB’s deal to buy CAM looks comparatively clean and straight forward. Schlumberger and Cameron do not have much in the way of overlap in their product portfolios, and Schlumberger has indicated it does not foresee significant antitrust issues in the approval of the deal. The purchase of Cameron will not substantially transform the much larger SLB, but it does offer a nice bolt-on acquisition at a time when stock prices are very reasonable across the industry. Related: Can Fuel Cells Help Clean Up China’s Air?

Given the industry circumstances, if the BHI-HAL merger does fall apart, it’s likely that neither firm would stay on the sidelines of the M&A game for long. Instead, both Baker Hughes and Haliburton would probably jump back in and look to take advantage of the fire sale pricing on a variety of smaller peers from Frank’s International to Weatherford.

To that end, Baker Hughes would be particularly well-positioned, given the roughly $3.5 billion break-up fee that it would receive from Haliburton. This cash would go a long way towards letting the ~$23 billion Baker Hughes pick up some consolation acquisitions of its own. In that respect then, even if a break-up in the Haliburton acquisition does eventually come to pass, BHI shareholders may find themselves in a strong position over the long term regardless of any short-term hiccups.

By Michael McDonald of Oilprice.com

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