Oil Services Crew On A Rig

Image Source: National Institute for Occupational Safety and Health via flickr.com.

Investors can get a little trigger happy sometimes, and this has been on full display these past few days as shares of Baker Hughes Incorporated (NYSE:BHI) have soared since the rumor broke that both it and Halliburton (NYSE:HAL) announced last week that they were looking at the potential of a merger, only to have the deal completed early this week. Before you decide to jump on this bandwagon, though, there are some things to consider.

Let's take a quick look at why traders -- I just can't get myself to call these buyers investors because it's buying on a rumor -- like the idea of Baker Hughes getting hitched to Halliburton, and why you might want to wait until something tangible happens at these companies before taking any drastic investment actions.

The temptation to buy Baker Hughes

It seems slightly strange that shares of Baker Hughes would pop as much as they did on Thursday when rumors of the deal broke, and then again once the deal was inked. Yet, in that same time, shares of Halliburton barely moved following the speculation, then have dropped close to 10% following the formal announcement. The simplest explanation I can give for this is that Baker Hughes needs this deal, while it may do little to improve the prospects of Halliburton.

If we look across the business profile of these two companies, we see that Halliburton has easily outpaced Baker Hughes in operational performance during the past few years. 

Company Revenue growth (last 5 years) Net Income growth (last 5 years) EBIT Margin (TTM) Return on Equity (TTM)
Halliburton  92% 161% 15% 23.3%
Baker Hughes 127% 68% 10.5% 7.2%

Source: S&P Capital IQ.

There are many reasons why Baker Hughes hasn't been able to stay up to par with Halliburton or the largest player in the space -- Schlumberger. The two big ones are that Baker Hughes' offerings have historically been lower technology, lower margin products and services, and that its performance in the international markets has consistently lagged behind its competitors.

If Baker Hughes merges with Halliburton, the combined companies will have immense market share in a couple of particular oil well services, as well as a strong presence in the North American market. In some small segments of the business, such as well casing and cement work, the combined entity would have almost 50% of the market. This, in theory, would give the company strong pricing power against producers who might look to shortchange service companies now that oil prices are hovering in the $80 a barrel range.

Be patient

If you're tempted to pick up shares in either of these companies because of the merger, just remember that the full details of the merger haven't been completed yet. On the chance that this deal doesn't happen because of regulatory issues or something else, Baker Hughes might walk away with a little extra change in its pocket--Halliburton will pay Baker Hughes $3.5 billion if the deal doesn't happen--but it could very well be the same company afterwards. That's the danger of dealing in speculation... it can be wrong.

The other thing that you need to keep in mind is that this could come under lots of scrutiny. According to Bloomberg Industries, some markets, such as the highly lucrative offshore contract tender market, would be almost exclusively dominated by this combined entity and Schlumberger. It's very possible that, in segments like this, it would need to unload some assets to adhere to antitrust laws both in the U.S. and abroad. Halliburton has already acknowledged that it is ready to shed business segments that generated $7.5 billion last year. 

Because these two companies operate in more than 80 countries, it will require jumping through lots of regulatory hoops to make it happen. We're not completely certain what the company will look like once the merger and subsequent asset sales hypothetically take place.

What a Fool believes 

Sometimes, doing nothing is the best course of action. Actually, in investing, the vast majority of what you should do is nothing, so you don't get tempted to overreact to the whims of the market. Until an actual deal between Baker Hughes and Halliburton happens, and we are fully aware of the ramifications it will have on the company's overall business profile, taking any investment decision now is an awful lot of speculation on something that still has a chance of falling through.

Besides, if the combined company is as good as the numbers suggest it could be, then the worst-case scenario is that you have waited a couple of months to grab a great company in the oil services business that has the potential to crank out several years worth of earnings power for you. Sounds like a fair trade. 

Tyler Crowe has no position in any stocks mentioned. You can follow him at Fool.com under the handle TMFDirtyBird, on Google+, or on Twitter @TylerCroweFool.

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