Hallliburton's (NYSE:HAL) $34.6 billion acquisition of rival Baker Hughes (NYSE:BHI) will make it the largest oil services company in the world by revenue -- that is, if regulators approve the merger. To get past antitrust regulations, Halliburton has said it's willing to sell off four overlapping units that have combined sales of $7.5 billion and that industry analysts expect will fetch Halliburton between $5 and $10 billion.
Let's take a look at why Halliburton is willing to sell these assets to ensure the approval of this mega merger, and which unexpected company may benefit as a result.
Why Halliburton wants this merger
Let's start with the most obvious beneficiary of the divestitures, Halliburton itself: Halliburton will benefit from both the increased likelihood of regulatory approval of the merger itself, and from the large amount of cash it would garner from the sales.
As this graphic shows, the large synergies that should be possible between its own assets and those of Baker Hughes stand to improve the capital efficiency and net margins of the combined company. That's important to Halliburton for two reasons.
First, Halliburton management thinks that Wall Street is valuing its shares at a discount to rival Schlumberger's (NYSE:SLB) -- currently the world's leading oil service provider. Management is confident that a much larger Halliburton, with both improved market share and profit margins, can earn a higher valuation that would be greatly beneficial to shareholders.
Second, a key metric used to determine bonuses and compensation at Halliburton is returns on capital. Thus, the cost savings from the merger could pose a direct benefit to management's pay.
However, investors also shouldn't overlook the potential for the larger Halliburton to benefit from increased pricing power, especially in key profit areas such as North American fracking. With the oil crash causing many oil companies to pull back on rig completions and demand much lower oil service rates, the ability to hold the line on pricing would not only be a major boon to Halliburton during this industry downturn, but would help in future ones as well.
The unlikely beneficiary
Emerson Electric (NYSE:EMR) may wind up a buyer of Halliburton's assets because In 2014 the company bought out the remaining 44.5% stake of EGS Electrical Group, a joint venture with SPX that derives about half its sales from the oil and gas industry.
Today Emerson has a thriving upstream business that helps both onshore and offshore drillers through its automation services, along with well chemical injection and control systems.
Halliburton's Sperry Drilling division -- which uses real time drilling data to automatically steer drill bits to where they can most easily reach oil -- makes a natural fit for Emerson since both businesses are involved in automating oil drilling. In addition, Sperry Drilling has long standing business relationships with oil producers that Halliburton has spent decades nurturing, and that Emerson might find very attractive.
Sperry Drilling is expected to cost around $3 billion and with $3.15 billion in cash, and annual free cash flows of $2.6 billion, such a purchase is certainly within Emerson's grasp.
What about Schlumberger?
Investors might understandably be wondering why Schlumberger, with $7.5 billion in cash on its books, wouldn't be the leading contender to buy these assets.
There are three reasons why I think this scenario is less likely. First Halliburton might not go for that because it would likely help Schlumberger to compete with it for future contracts, and it might also raise the ire of regulators who may not wish to see further consolidation in the industry.
Finally, there's the fact that Schlumberger has higher returns on capital than either Halliburton or Baker Hughes and might simply not want to buy assets that are less profitable than what it already owns and that would decrease its existing margins.
Takeaway: Halliburton-Baker Hughes merger creates potential win-win situation for several companies
While the biggest winner of the Halliburton-Baker Hughes merger is definitely Halliburton itself, other companies such as Emerson Electric stand to benefit as well. While I certainly wouldn't recommend that investors speculate on these potential asset purchases by investing in Emerson purely for this reason, I think that -- if it does wind up buying some of these assets -- its stronger presence in the oil and gas services industry would certainly make Emerson a more attractive long-term income investment.