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Halliburton-Baker Hughes Merger Dead? Saturday Deadline Looms

Halliburton Co. laid off more than 6,000 additional people during the first quarter, and it signaled that its mega-merger with Baker Hughes Inc. is in danger of collapsing.

The No. 2 oilfield services (OFS) giant and North America's top hydraulic fracturing company issued its quarterly results last Friday and was scheduled to hold a conference call with analysts on Monday. However, the call was delayed until next Tuesday (May 3), with Halliburton citing its upcoming deadline to complete the tie-up with Baker, the No. 3 OFS operator.

While some energy analysts said the delayed conference call was not a good sign, CEO Dave Lesar kept his written comments to the latest financial results, which were far from encouraging. Total company revenue fell 17% from the fourth quarter to $4.2 billion, driven by the sharp decline in North America. Producers' capital spending is seen falling even more this year than some have projected.

Producers ‘Cautious’ Going Forward

"Life has changed in the energy industry, especially in North America, and over the past several quarters we have taken the steps to adapt to that fact," Lesar said. "Operators globally are under immense pressure, and many of our North America customers are fighting to maintain some value for their shareholders. Our goal is to work with those customers to get through these tough times.

"Our customers have taken defensive actions to solidify their finances, including significant reductions to headcount and capital spend. While these were necessary actions, it clearly will result in production declines in the back half of 2016. But even when operators feel better about the markets, they will still face issues of balance sheet repair, and we believe they will be cautious in adding rigs back.

"As activity levels recover, we believe there will be a structural shift to lowering cost per boe, through more collaborative business models with service providers, more aggressive application of our industry-leading technologies, and less duplicative costs."

North America experienced "another tough quarter," President Jeff Miller said. "What we are experiencing today is far beyond headwinds; it is unsustainable. My definition of an unsustainable market is one where all service companies are losing money in North America, which is where we are now. However, our margins have continued to show resilience despite the aggressive activity and pricing declines we have seen since the peak, with decremental margins of only 22% for the quarter."

From its peak in the final quarter of 2014, the U.S. rig count has declined by nearly 80%, setting a record low. "By comparison, our North America revenue is down 62% over the same period, again outperforming our peers, and operating income has only now slipped to a quarterly loss position," Miller said. But already in the second quarter, the "average land rig count is already down more than 20% sequentially, and setting new record lows every week."

Regardless, "we believe we will see the landing point for the U.S. rig count during the second quarter. Once we see stability in the rig count, our cost cutting measures will start to catch up. Previous downturns indicate that there is typically at least a one quarter lag after the rig count flattens before we see our margins begin to improve."

The industry is facing one of its most challenging periods ever, Lesar said. "Further, we expect to see an additional 50% decline in North America spend in 2016, following last year's 40% decline."

Because of the pessimistic outlook, management took a hard-nosed look at the business from three perspectives: what its customers are doing, what competitors are doing and what it can do.

"Many customers are struggling to survive and maintain some value for their investors," the CEO said. "They are doing this by cutting their capital costs, drilling their best acreage, pushing service pricing down, stretching payment terms and radically restructuring their balance sheets through debt to equity conversions or dilutive equity deals. A large number of competitors, especially in North America, are rebasing their cost structures downward, in many cases by converting their debt to equity, and underinvesting in areas such as maintenance and technology, while continuing to price service work at less than cost.

"At Halliburton, we revisited every cost from manufacturing to delivery logistics to field operations. This included looking hard at capital equipment needs, required headcount and service delivery infrastructure. It was easy to conclude after this assessment that the industry is grossly overcapitalized, especially in North America. To reflect our current estimate of market requirements, we took a $2.1 billion after-tax restructuring charge in the first quarter related primarily to asset write-offs and severance costs."

Cold Stacking Pumping Equipment

There is "excess service capacity across all of our product lines, with the largest single component relating to our North America pressure pumping business."

Halliburton has over the past four years been converting its North American pressure pumping fleet to its "Frac of the Future" design using its Q10 pump systems (see Daily GPIJuly 24, 2012). The Q10 system has resulted in such strong results that Halliburton has impaired "a large portion" of its older, pre-Q10 pumping equipment.

"Depending on the age and condition of this equipment, it has either been permanently removed from the fleet, or it has been cold-stacked," Lesar said. "When market conditions improve, we have multiple levers we can pull, including accelerating the manufacturing and deployment of additional Q10 units."

And because of the new "reality of the market," Halliburton has further consolidated management and centralized support functions, resulting in a workforce reduction of 6,000-plus in the first quarter. Since the downturn began in 2014, it has reduced its global headcount by about one-third.

At the end of March, Halliburton had closed or was in the process of closing more than 100 different service points worldwide, ranging from eliminating underutilized stock points to consolidating individual service centers.

"In addition, our view of the fundamental changes to the market has led us to take action and reduce the infrastructure that had been maintained in anticipation of the pending Baker Hughes acquisition," Lesar said. "We are not making any decisions that would permanently impair our logistical infrastructure, or ability to flex back up, but we see no scenario in the current market where we need this additional infrastructure. We have demonstrated in the past that we have the ability to react quickly in a recovery and expand the business while maintaining higher incremental margins than our competitors."

North America revenue in 1Q2016 was $1.8 billion, a 17% decrease sequentially, with an operating loss of $39 million. The declines were driven by reduced activity throughout the United States land sector, particularly pressure pumping services, along with a decrease in completion tools sales in the Gulf of Mexico. International revenue fell 18% from the fourth quarter.

Completion and production revenue fell 18% from the final three months of 2015, while operating income slumped 79%. Drilling and evaluation decreased 17% sequentially while operating income dropped 40%.

Tudor, Pickering, Holt & Co. (TPH) analysts said the quarterly results won't be first on the minds of investors as the merger deadline approaches, but they said Halliburton was doing what it does during downturns, "taking U.S. completions market share..." Completions activity was off less than 10%, with relatively shallow 22% decrementals, proving that the company likely is faring "much better than those of its competitors."

Cold stacking its old pumping equipment "illustrates why we see notable industry attrition on the come." Halliburton's U.S. fleet has around 2.6 million hydraulic hp (hhp), with 60% of its fleet converted to Q10 pumps, which means that around 1 million hhp may exit the fleet/enter cold stack. That would lend "beaucoup credence" that there may be 5-8 million hhp stacked as the upcycle begins.

Baker Tie-up Said Unlikely

The Baker merger, originally worth about $35 billion, was expected to take about a year to complete after it was announced in late 2014, but it has faced delay after delay (see Daily GPIDec. 15, 2015July 13, 2015Nov. 17, 2014). The U.S. Department of Justice (DOJ) in early April also filed a lawsuit to scuttle the merger, claiming it would eliminate significant head-to-head competition (see Daily GPIApril 6). Last week the European Union regulator reportedly also warned Halliburton that it would block its completion.

The partners had imposed an April 30 deadline to obtain regulatory approvals, "after which the parties may continue to seek relevant regulatory approvals or either of the parties may terminate the merger agreement," Halliburton said.

"We don't think Halliburton would delay its first quarter earnings call until after April 30...if it felt good about the likelihood of this merger eventually consummating," TPH analysts said. It's also telling that the company "decided to reduce infrastructure previously maintained in anticipation of the acquisition...This protracted...saga is nearing an end, but the stock market was already assuming as such," given the 40% deal arbitrage spread.·

Jefferies LLC's Brad Handler said postponing the conference call signals that Halliburton and/or Baker will terminate the merger. "We believe that investors largely expected this once the DOJ filed its suit to block the merger in early April and thus expect limited share price reaction," Handler said.

Robert W. Baird's Daniel Leben agreed, noting that the news is a sign that the merger "will break" after Saturday. He expects Halliburton to remain acquisitive, "although we do not expect anything in the near term," as it continues to restructure.

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