On Halloween morning, the companies busted out the treats with the news that GE plans to merge its oil and gas unit with Baker Hughes and then spin it off as a separate entity called The New Baker Hughes. This is probably good news for shareholders of both companies. Here's why.
What does it mean for GE's shareholders?
When the transaction closes -- which is slated for mid-2017 -- GE will own 62.5% of the New Baker Hughes, which will be spun off as a separate publicly traded company.The move is probably a good thing for General Electric's shareholders. Low energy prices have hit GE's oil and gas division hard, and it's been underperforming the company as a whole for more than a year.
In the recently completed third quarter of 2016, GE's oil and gas revenue was down 25% from Q3 2015 -- the worst performance in the company. This wasn't a case of just one bad quarter, either. Over the first nine months of the year, oil and gas revenue was down 21%. This was offsetting good performance elsewhere in the company's portfolio and affecting the company's bottom line.
Yet it seemed that CEO Jeff Immelt and GE's Oil & Gas Division CEO Lorenzo Simonelli were actually planning to increase their oil and gas holdings. The company had been eyeing Baker Hughes' drilling unit when it was scheduled to be spun off earlier this year. Turning this lackluster unit into a separate company controlled by GE should free GE's portfolio from the dead weight while also allowing GE's management to put its oil and gas expertise to good use.
What does it mean for Baker Hughes shareholders?
When the transaction closes, Baker Hughes shareholders will receive a special one-time cash dividend of $17.50 per share and 37.5% of the New Baker Hughes. More importantly for the long-term prospects of the company, they'll also benefit from the economies of scale this transaction generates. The company had planned to merge with rival oilfield-services company Halliburton (NYSE: HAL) before regulators killed the deal in May 2016. That left Baker Hughes an unenviable distant third in the oilfield-services market behind Halliburton and Schlumberger. As a result, it had far less pricing power than its larger rivals, as evidenced by its profit margin and return on equity, which have been been lower than the others' for nearly a decade.
But with combined revenue of over $32 billion, the New Baker Hughes will overtake Halliburton as the second largest player in the oilfield equipment and services industry, according to a company press release. The New Baker Hughes will have operations in more than 120 countries. But size isn't the only advantage Baker Hughes will gain. A partnership with GE will open up the company to lucrative new revenue streams.
A perfect pair
There isn't much overlap between the two companies' operations. Baker Hughes, for example, has drilling, boring, and fracking operations absent from GE's portfolio. Meanwhile, GE has extensive subsea, offshore, and liquefied natural gas businesses that fill gaps in Baker Hughes' offerings.
Even more importantly, the New Baker Hughes will be moving beyond oilfield services and into oil and gas productivity solutions, a GE hallmark that is all but absent in Baker Hughes' current portfolio. GE can bring its expertise in data analytics, including its powerful Predix industrial internet platform to the New Baker Hughes, which will help its customers to make their drills, rigs, and other oilfield machinery more efficient.
Baker Hughes CEO Martin Craighead summarized the advantages: "This compelling combination brings together best-in-class oilfield equipment manufacturing and services and digital technology offerings for the benefit of all customers and stakeholders. The combination of our complementary assets will create a platform capable of seamless integration... ."
Even better for shareholders, the complementary portfolios will probably allay some of the regulatory concerns that killed Baker Hughes' proposed deal with Halliburton, with which it shared several business lines and markets.
There are a few potential pitfalls before the New Baker Hughes becomes a reality. The companies' shareholders have yet to approve the deal -- although, given the advantages for each, one would expect that to happen smoothly -- and the regulators will need to sign off on it. Until the ink is dry, investors should take this merger with a grain of salt.
But if it goes through as planned, both companies -- and their shareholders -- stand to benefit handsomely from the economies of scale and the synergies between the two companies' portfolios. Baker Hughes shareholders will also gain from the special dividend, and GE shareholders will benefit from the removal of the lagging oil and gas business from the company's portfolio. This deal strengthens the bullish thesis for both companies.
John Bromels has no position in any stocks mentioned. The Motley Fool owns shares of General Electric and Halliburton. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.