GE Has Good Reasons for Bakers Hughes Partnership

(Bloomberg Gadfly) -- General Electric Co. is taking some liberties with the definition of "partnership," but getting creative in its deal with Baker Hughes Inc. works to its benefit.

Just a few days after GE insisted it was only exploring partnerships with Baker Hughes, rather than a speculated outright takeover, the company announced an arrangement whereby it's more or less acquiring Baker Hughes. GE will own 62.5 percent of a newly formed entity that combines its oil and gas division with Baker Hughes. The company will also put up $7.4 billion in cash to cover a $17.50-per-share special dividend for Baker Hughes shareholders.

It's a pretty sweet deal for Baker Hughes. According to GE, the transaction values the oilfield equipment provider at 11 times its projected 2018 Ebitda before accounting for synergies. That suggests an enterprise value of more than $25 billion, a roughly 13 percent premium to Baker Hughes' valuation before news of the company's talks with GE surfaced last week. Taking into account cost savings, analysts from Raymond James estimate an implied enterprise value for Baker Hughes of as much as $30 billion, closer to a 30 percent premium.     

Keep in mind that Baker Hughes' "unaffected price" was actually higher than what the company was trading for before it inked a deal to sell itself to Halliburton Co. in 2014. If it walks like a merger, talks like a merger and carries a premium…

While the Halliburton-Baker Hughes transaction ultimately failed amid antitrust pushback, GE is betting it can create a stronger competitor to Schlumberger Ltd. without ruffling as many regulatory feathers. Baker Hughes' drilling equipment will give GE a more complete portfolio to offer cash-strapped customers. The deal also gives GE more products to sync up with its cloud-based Predix software platform (like Android, but for industrial companies) as it seeks to generate $15 billion of digital revenue by 2020.   

Targeted cost savings and revenue benefits of $1.6 billion should help GE close the gap on its goal of achieving $2.00 in earnings per share by 2018 -- something that had looked increasingly challenging as the company struggled to find organic growth. Help is the key word there; GE expects to get an EPS boost of 4 cents in 2018 from the Baker Hughes deal, about a 2 percent increase. Such weak accretion in exchange for a $7.4 billion cash payment that will soak up a pretty good chunk of GE's $20 billion in deal firepower may be one reason why the stock was basically flat on Monday. That, and the fact that this is a much more complicated deal to digest than an outright takeover.

Complicated doesn't always mean bad, though. GE clearly was at pains to communicate to shareholders that it wasn't going to repeat history after buying oil-well pump maker Lufkin Industries Inc. in 2013 at what was then the industry's most expensive price tag -- just before the plunge in oil prices. The arrangement with Baker Hughes may not be the cheapest thing, but there are some mitigating benefits. For one, it's tax efficient. GE says it can reap as much as $1 billion of tax benefits based on the way the deal is structured and because of the newly formed entity's dual headquarters in Houston and London.

The arrangement also has the handy feat of both adding to GE's oil and gas assets to make them better, while at the same time distancing the company from a business that's been a significant drag on its revenue and profits as crude prices plunged.

The company's ongoing ownership of the oil and gas operations means that shareholders will get to reap the benefits when those assets inevitably start performing a little better. The actual earnings accretion that GE gets from this Baker Hughes transaction may wind up being higher if oil prices rebound above the $45-to- $60-a-barrel range that the companies are targeting. But once that upside is realized, GE could explore spinning off the energy business to shareholders. The Baker Hughes transaction doesn't preclude a later spinoff and in some ways, makes it easier to structure something like that, GE executives said on the call Monday to discuss the deal.

GE's massive divestiture of its finance assets kept investors satisfied for a while, but questions were already bubbling back up about whether the conglomerate was still too big for its own good. GE arguably just got bigger, but it also got a little simpler -- albeit in a complicated way. And that should make investors happy.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

1. GE and Baker Hughes do have some overlap in artificial lift, but their technologies are differentiated enough that divestitures should be pretty minimal if they happen.

To contact the author of this story: Brooke Sutherland in New York at bsutherland7@bloomberg.net.

To contact the editor responsible for this story: Beth Williams at bewilliams@bloomberg.net.