Schlumberger Ltd., already the largest oilfield services contractor in the world, could take on more natural gas shale drilling once its acquisition of Smith International Inc. is completed, the CEO said Monday.

The two companies agreed to merge on Sunday in a transaction estimated to be worth around $11 billion. Once completed, Smith would own about 12.8% of Schlumberger.

Negotiations with Smith had "been going on for a long, long time," Schlumberger CEO Andrew Gould told financial analysts during a conference call Monday (see Daily GPI, Feb. 22). "We have never up until now reached a point where we felt that the price Smith wanted was something we could afford." Also of help in the negotiations: Smith CEO John Yearwood spent two years as Gould's senior adviser and CFO William Restrepo also once worked for Schlumberger.

Under initial terms in the agreement Smith was valued at $45.84/share, a near 38% premium over last Thursday's closing price, which put the deal's worth on Sunday at about $11.34 billion. By midday Monday the merger's value had declined to around $10.33 billion, as Schlumberger stockholders sold off their shares at a record rate.

The offer to Smith was at a "significant premium," but Gould said it would pay off in what his company will gain.

"At our investor event in September 2008, we highlighted that increased levels of drilling are required to sustain and increase world oil and gas production," said Gould. "Increasingly, those wells are being drilled in more challenging environments and in new resource plays, with longer and more complex profiles. Schlumberger is already the leader in the measurement and steering technologies that are necessary to drill these profiles.

"We firmly believe, however, that the next breakthrough will be through engineered drilling systems that optimize all the components of the drillstring, allowing our customers to drill more economically in demanding conditions. This step change in drilling performance and well productivity must come from combining measurement and steering capabilities with the engineering and design of the complete bottom-hole assembly and its various components -- including the drilling fluids and drillbit -- with the hydraulic and mechanical environment in which they operate."

Asked about opportunities in shale gas drilling, Gould said, "No doubt, in the long term, shale gas is going to be one of the big new energy sources in the U.S. and overseas. The capacity to serve that market in North America is of great interest to me."

Smith, headquartered in Houston, has "drilling technologies, other products and expertise" that "complement our own, while the geographical footprint of Schlumberger means we can extend our joint offerings worldwide," said Gould. "We believe this transaction brings significant benefits to the customers and shareholders of both companies, and we look forward to welcoming Smith employees to Schlumberger."

Smith's assets, which include turbines and drillbits, give Schlumberger an opportunity to produce new products. Among other things, Smith's Wilson distribution business, which provides piping to energy companies, in 2009 produced $1.8 billion in revenue.

"We see a real opportunity in the Smith distribution business," said Gould. "We believe that in a combined company, Wilson could realize its full potential through global expansion opportunities that we can provide while improving our own internal supply chain services." Schlumberger now operates in more than 80 countries; the merger also would give it control over M-I SWACO, a drilling fluids business the companies have jointly owned since 1999.

Yearwood said the transaction would give his shareholders "significant value and the opportunity to integrate with and own a meaningful share of a recognized technology leader in an extensive number of fields. Schlumberger offers Smith's various segments enhanced engineering and design capability to place our products and expertise at the center of the total drilling system of the future. We look forward to a successful combination with Schlumberger and have no doubt that our customers will see accelerated technology development and that our employees will enjoy enhanced opportunities."

The tie-up is the second major announced transaction in the oilfield services sector in less than six months. Last August Baker Hughes Inc. announced that it would buy BJ Services Co. for $5.5 billion in the largest oilfield services acquisition in more than a decade (see Daily GPI, Sept. 1, 2009). Federal regulators have yet to sign off on the transaction, which is expected to close this year.

The transaction between Smith and Schlumberger is subject to stockholder approval and various regulatory approvals; the closing also is expected later this year. Goldman, Sachs & Co. acted as financial adviser and Baker Botts LLP served as legal counsel to Schlumberger. UBS Investment Bank acted as financial adviser and Wachtell, Lipton, Rosen & Katz served as legal counsel to Smith.

Citigroup analysts said they expect a "loud chorus of analysts to claim that Schlumberger is overpaying for Smith. In our view, they are wrong. We believe that Smith's drilling fluid and drill bit business will play a critical role in Schlumberger's next generation of technologies aimed at drilling economically in the most challenging and complex well conditions."

Analysts with FBR Capital called the merger between Smith (SII) and Schlumberger (SLB) a "smart strategic move...There's been talk about integrating all the components of the bottom hole assembly for some time, but SLB had generally shrugged off the question of 'owning' bits by saying it wasn't necessary. Their prior commentary had been that all that was needed was having access to the technology...Yes, SII's earnings have materially underperformed to explain much of this, but SLB views this deal (and we agree) as being able to advance the SII earnings stream beyond what SII could have done alone (with cost saves as an added kicker). Patience is paying off here for SLB..."

After integration costs Schlumberger expects to realize incremental pretax synergies of around $160 million in 2011 and $320 million in 2012. The combination would be accretive to earnings in 2012, it said.

The merger could eliminate a lot of jobs in the Houston area, according to some analysts. Smith, which employs close to 21,000 worldwide, has around 3,200 employees in Houston. Schlumberger, with corporate offices in Houston, Paris and The Hague, Netherlands, employs 77,000 worldwide, with 5,000 in Houston. Executives avoided detailing specifics during the conference call.

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