General Electric and Baker Hughes' Merge in a Bullish Bet on the Future of Energy

Last week, GE (GE -2.11%) and Baker Hughes (BHI) announced plans to merge in a deal that would create the second-largest oil field services company in the world.

In this video segment from Industry Focus: Energy, Sean O'Reilly and Taylor Muckerman break down the financial details of the deal, then dive into what both companies will be getting out of the merger -- from more exposure to a recovering oil market to IP exchange and more. Also, the hosts go over how shareholders will be affected by the deal, and how much sense the merger makes for both companies.

A full transcript follows the video.

This podcast was recorded on Nov. 1, 2016.

Sean O'Reilly: One of the largest industrial conglomerates on this planet --

Taylor Muckerman: Any planet that we know of.

O'Reilly: That we know of. We have not explored Mars a ton, but it's there. GE decides to buy Baker Hughes for $30 billion.

Muckerman: Well, no, they're not buying them, they're just merging with them. They're forming a merger with their oil and gas unit. Basically, they're writing a $7.4 billion check to Baker Hughes shareholders for 2/3 of the company, or of the combined joint venture.

O'Reilly: Right, which will be about $30 billion.

Muckerman: $32 billion in annual revenue.

O'Reilly: What was your first thought when you saw this come across the wires? I got the push notification from Bloomberg on my phone. Clearly, GE has been trying to shift away from the GE Financial Services type thing and just get rid of all that.

Muckerman: Yeah, they've gotten rid of about $200 billion in assets in GE Capital.

O'Reilly: Be the premier manufacturing industrial company in the United States of America. This is a good way to do it, I guess?

Muckerman: So, they're already, if not the largest, one of the largest oil and gas equipment manufacturers in the world. And now, through this joint venture, it's going to create the second-largest oil field services company in the world. They overtake Halliburton. Right there, I was like, son of a gun, my boys at Halliburton tried to make this deal happen, where they would officially merge with Baker Hughes, and that obviously didn't go through after a year of legal battles with regulators. Now you have GE stepping in. It's kind of interesting, because they've spent $14 billion or so over the last decade on oil and gas acquisitions. Now, they're hinting that, potentially, they could spin that business off one day. 

O'Reilly: I was kind of surprised, because Baker Hughes, even if and when there's a decent recovery in the energy sector, they weren't projected to be making gobs of money for years. I looked at multiple reports this morning, and I popped over to S&P Global Market Intelligence, looked at the analysts they polled. And you should take anything these people say with a grain of salt, but, bottom line, they've just been cost-cutting like everybody else, they've been pruning product lines, focusing on the lines that have a hope of making a decent profit margin. What does GE see? You would have to be looking way down the line.

Muckerman: They see a greater exposure to a recovery in oil and gas. Now, they're not just an equipment manufacturer, they're actually a services company. And they do sell equipment to Baker Hughes, so there are some synergies that could be exposed there. They say they'll continue to sell equipment to other service providers outside of Baker Hughes, which I would have to imagine, that would be part of any regulatory approval. You can't just go ahead and cut off the faucet to other competitors. You look at this, they still expect oil to be around $45 to $60 a barrel out until 2019, the end of that year. So, they're not expecting a big, huge recovery. $60 a barrel isn't too far off, it's maybe a 20% increase in oil prices. But in the grand scheme of things, it's still half of what it was a few years ago.

I think this is just them placing a bigger bet on a recovery, maybe not an immediate one, but yeah, a sustained recovery in oil and gas, and the technological advantages they can probably discover by combining a services company with an equipment company. You get a little bit better communication, you might understand some changes that need to be made in the products that GE was originally making, more so than if Baker Hughes was just giving them feedback as a customer. I think there's a little bit more incentive there to align product and service.

O'Reilly: It's funny you bring that up, because, again, most people don't realize, Baker Hughes is in 80 countries.

Muckerman: Yeah, they're very widespread.

O'Reilly: Europe, North America, they're off the coast of Africa, I believe they're a little bit in the North Sea in terms of operations. It's interesting you talk about the information, though.

Muckerman: Yeah, I mean, there's definitely going to be some exchange there. You would have to imagine that IP would be one of the big reasons why GE thinks this could work out. And then you think about GE as a whole: They have a $25 billion aviation business, they have a $21.5 billion power business, almost $18 billion healthcare business. All those are 2015 revenue levels. But if they can do this with their oil and gas business, which is about $16 billion, what other kind of joint ventures could they do or possibly spin out into a separate entity from these other companies, that would be a meaningful player on their own in any of those industries I just mentioned?

O'Reilly: Yeah. So, do you like the deal, bottom line?

Muckerman: Bottom line, yeah, I think it gives GE good exposure to oil and gas. I was surprised they didn't make more acquisitions within the last year, closer to the bottom of the cycle, when oil was in the $30 range. It seemed pretty unfathomable that it would remain that low for an extended period of time. And, they had the capital. So, obviously, they didn't issue any shares for this. They're just forking over some cash. Some as in $7.4 billion. Yeah, I was surprised that it took this long for GE to make a move.

O'Reilly: At least buy more parts manufacturers.

Muckerman: Yeah, something. They probably made a few tack-ons that didn't really make a big splash in the news. But I was expecting something similar to this -- maybe not the same structure, but maybe the same dollar tag, to bring somebody on board that could help them take advantage once oil prices rise.