Halliburton Acquisition Launches New Era of Oil Consolidation

Thirty-four-point-six billion dollars. That’s how much oil services giant Halliburton (NYSE: HAL) is paying to acquire one of its rivals, Baker Hughes (NYSE: BHI). The megamerger will bring together the second- and third-largest companies in the oil exploration industry.

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The Halliburton acquisition is likely the beginning of a new era of consolidation among companies associated with oil and gas exploration. With oil prices falling to five-year lows many of the oil producers driving America’s energy boom are operating at or near break-even levels.

Thus, the reward for finding and extracting oil at new sites has dropped considerably, bringing the prices of these stocks along for the ride.

Oil prices have now fallen roughly 40% since June. Companies involved with oil exploration and companies involved with more expensive forms of oil production have been hit hardest.

Deepwater rig company Seadrill (NYSE: SDRL) is now down 70% from June levels while Transocean (NYSE: RIG) stock has fallen 60%.

Shares of Halliburton are down 44% during the same period. Meanwhile, even with a surge in price following news of the Halliburton acquisition, Baker Hughes remains 25% below June levels.

Even shares of oil giant Exxon Mobil (NYSE: XOM) are down 12% since June, while the S&P 500 has risen almost 4% over the same period.

With such depressed stock prices it should come as no surprise that merger-and-acquisition activity is ramping up within the industry. The Halliburton acquisition of Baker Hughes is a big one – perhaps the biggest that we’ll see. But it certainly won’t be the last oil-industry merger.

Seadrill declared earnings on Nov. 26, announcing weak third-quarter results and a suspension of its huge dividend. The stock was yielding around 20% at the time, a sign that investors – myself included – expected the dividend to be cut.

But I doubt many expected Seadrill’s dividend to be suspended entirely. The stock fell roughly 23% that day, reacting sharply to the news and eliminating approximately $3 billion in market value.

The slide didn’t stop there. Including the huge fall after earnings, the stock is now down 42% in just nine trading sessions. Ouch.

When Seadrill suspended its dividend – which management had previously promised would be sustainable until late 2015 – the company stated that the move is “a preemptive dividend cut in order to pay down debt and focus on opportunities that may arise.” To ease shareholders’ pain, Seadrill also announced a share buyback program, with authorization to repurchase up to 10% of outstanding shares.

These are MAJOR moves for the deepwater rig operator. The company’s stated desire to reduce debt seems like a prudent move in the face of an uncertain future. But it’s the other two stated reasons behind the dividend suspension that interest me most.

Seadrill, along with many others in its industry, has been hit hard. And if you believe oil prices will eventually return to previous levels, these stocks represent a tremendous value right now. That’s why Seadrill wants to buy back up to 10% of its own stock and that’s why it wants to improve its balance sheet and ability to purchase additional rigs and other companies.

The reality is that oil stocks are huge acquisition targets right now, and the Halliburton acquisition of Baker Hughes is likely the first of several major acquisitions we’ll see in the industry. The only questions left in my mind are which companies will be acquired and how long it will take for oil to regain previous levels.

When it happens, the beaten-down companies that are bought out could be in for a major rally. Better get in now while they can be had for bargain prices.

Disclosure: I personally own shares of Seadrill.

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