Germany's Siemens (OTC:SIEGY) is on a shopping spree. Earlier this year it acquired the energy business of Rolls-Royce, and now it is buying Dresser-Rand Group (NYSE: DRC) in an epic deal worth $7.6 billion ($83 a share) in cash. Dresser-Rand is counted among the largest suppliers of equipment solutions to the energy sector.
According to Bloomberg, the deal is expensive, as it values Dresser-Rand at 14.1 times its 2015 consensus EBITDA before cost savings, compared with a median 9.2 times EBITDA paid for similar transactions. But Siemens might be shelling out the premium to cash in on the up-cycle in the U.S. oil and gas exploration market. It could also be looking to take on its bigger rival in the energy business, General Electric (NYSE:GE). Let's find out more about the deal and what it means for the involved parties.
Possible reasons behind the move
Bloomberg reports that Siemens expects oil and gas spending to grow by 6% to 8% from 2016 onward. Siemens CEO Josef Kaeser said on a conference call that there has been a downturn in the U.S. oil and gas segment in 2014, but he expects that to bottom out in 2015 and an up-cycle to begin in 2016. Adding weight to this rationale is the International Energy Agency forecast that the U.S. will beat Saudi Arabia in oil production by 2020 on the back of the shale boom.
Siemens is a latecomer to the oil and gas scene, which GE has invested $14 billion in over the last seven years. But it wants to make up lost ground, and with that intent it acquired Rolls-Royce's power business for $1.3 billion in May. Bloomberg noted that Siemens has been mulling over a bid for Dresser-Rand for at least three years.
The company's other objective behind the bid is to increase its competitive edge against GE. Reuters reports: "The acquisition, which ranks among the biggest in the history of the industrial group, will strengthen Siemens' position in the United States, its weakest region, and bring it nearer catching up with rival General Electric Co."
How will Siemens benefit from the deal?
According to a recent JPMorgan Chase report, Siemens' offerings are mostly concentrated in midstream and downstream applications, while it has a product gap in the more lucrative upstream and LNG applications. The Dresser-Rand deal should help the company fill these gaps and compete better in upstream markets. The two companies complement each other in terms of offerings: Siemens is a key manufacturer of gas turbines and a major supplier of equipment used in natural gas extraction, while Dresser-Rand makes rotating equipment such as turbines and compressors. With an expanded product portfolio, Siemens would benefit more from hydraulic fracturing in the U.S.
Siemens' oil and gas operations will expand to about $11 billion, large enough to bring "consistent and growing stream of profitable service revenue from day 1" and long-term backlogs. Even the spare parts business of Dresser-Rand could become a steady source of recurring revenue, as pointed out by analyst Robert Norfleet.
Siemens expects to obtain annual synergies worth euro 150 million ($190 million) by 2019. Additionally, more than half of Dresser-Rand's service offerings fetch high margins that will help Siemens expand its own profit margins from the beginning.
How does this affect General Electric?
The U.S. conglomerate has been active in the consolidation of the oil and gas industry over the last 10 years and has made a good number of deals to strengthen its portfolio, which stands at $17 billion. It acquired Wellstream in 2010, Wood Group's well support division in 2011, Lufkin in 2013, and Cameron's reciprocation compression business earlier this year, to name a few. It was also interested in Dresser-Rand. However, now that the Siemens deal has received the nod from the majority of Dresser's board of directors, GE is unlikely to make a counterbid. When GE and Siemens last faced off in a bidding battle, the U.S. company bagged Alstom.
Apart from the lost opportunity, one additional possible negative is that Dresser-Rand won't be buying machines, such as aero-derivative gas turbines, from GE anymore. Siemens will prefer to meet the requirement either through its own offerings or Rolls-Royce's.
Had things worked out between GE and Dresser-Rand, it could have led to grave antitrust concerns, since the deal would have made GE too powerful in the space.
Siemens is trying to become a more potent force by addressing its weaknesses. The gaps Dresser-Rand will help fill should put Siemens in a better position to compete with GE. As for GE, it has a rock-solid hold on the U.S. market, and though the deal will give Siemens a chance to come closer, the German behemoth will still have a lot of catching up to do.