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Merger Forms Biggest Fish in Drilling Industry Pond

Merger Forms Biggest Fish in Drilling Industry Pond

Schlumberger Ltd, one of the largest oil services companies in the world, decided last week to spin off Sedco Forex Offshore, its offshore drilling company, and allow it to enter into a merger agreement with Transocean Offshore Inc. for $3.2 billion in the resultant company's stock. If approved by regulators, the combination will form Transocean Sedco Forex, the largest offshore drilling company in the world.

The new drilling giant will have operations in all of the world's major offshore drilling regions including the North Sea, the Gulf of Mexico, Southeast Asia, West Africa and Brazil. It will have one of the world's largest offshore rig fleets with 75 units. On a market capitalization basis, the merger will form the fourth largest oil services company worldwide behind Schlumberger, Halliburton and Baker Hughes. The combined worldwide work force will consist of 7,500 people and have its principal offices in Houston, TX.

"The merger of Transocean Offshore with Sedco Forex Offshore is advantageous due to the rising capital costs for new rig construction, the increasing size and needs of our customers, the expanding geographic diversity of offshore drilling and the technical challenges posed by new deep-water drilling activities," said J. Michael Talbert, CEO of Transocean Offshore. Talbert will be CEO of the new company. "Transocean Sedco Forex will be uniquely positioned to address these challenges due to its technical leadership, financial strength and global presence."

Under the terms of the agreement, Schlumberger shareholders would own 52% of the new company by trading in their shares at a ratio of five Schlumberger shares to one Transocean Sedco Forex share. The deal has already been approved by the board of directors for each company and is expected to close by Dec. 31, 1999.

"This had to happen," said one analyst who wished to remain anonymous. "There has been so much convergence on the other side. Giant exploration and production (E&P) companies are forming, but the rig construction industry has been lagging behind. In order to succeed, you've got to keep pace with your customers. The big move these days is to drill in deepwater, which is an expensive endeavor. By merging, the combined company will now have a more impressive resource base to attract the BP Amocos and the Exxon-Mobils of the world who favor the more expensive projects." He noted that the rig construction industry is not devoid of consolidation, siting the Halliburton-Dresser Industries and the Reading & Bates-Falcon Drilling deals, but it was not happening at the pace of E&P consolidation.

Arvind Sanger, an analyst with Donaldson Lufkin and Jenrette Securities Corp., said the merger may help the industry recover from the recent oil price slump. Oil prices bottomed out in 1998, reaching record lows of under $13/barrel. Current prices fall in the $17-$20/barrel range. "The rig construction industry is fragmented right now. By joining forces, these two major players no longer have to bid against each other or compete in any way. Now, we all know the Justice Department won't let a combination occur if it will affect prices, and I don't think this merger is big enough to do that anyway. But it will get people evaluating their positions, and this company could have some bargaining power."

Sanger said the long-term winner in this deal could be Schlumberger. "In the short-term, the results are market-dependent. It's famine time right now, but when the rig construction industry is going well, it goes well for everybody. If the recovery continues, who knows? In the long run, however, I think Schlumberger did the right thing because it is better to be an oil services company than an oil service and rig construction company. There is less risk and more reward." Sedco Forex's net income was $390 million in 1998, and Schlumberger said it expects the drilling company to represent 15% of its annual net income for 1999.

John Norris

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