As risky as General Electric Company‘s (NYSE:GE) deal to merge its oil and gas business with Baker Hughes Incorporated (NYSE:BHI) is, most analysts see it as a net positive for GE stock.
The combination of these two operations will create the world’s second-largest listed oilfield services group. The industry has been reeling because of low oil prices and that remains a challenge, but that also makes it the right time to strike.
After all, the idea is to buy low, and BHI is worth a lot less than it used to be.
Additionally, the deal allows GE to remove the oil and gas business from the company’s core results. That’s because the combined company will be a joint partnership between shareholders of both firms and will get its own listing.
GE will own 62.5% of the “new” Baker Hughes. This way, GE maintains exposure to the oil and gas industry while sharing some of the risk. And, of course, the elimination of overlapping costs is always welcome. That’s even more true when low energy prices are sapping margins.
Running through the details, there doesn’t appear to be anything that changes the investment thesis on GE stock. The new company will nip at the heels of No. 1 player Schlumberger Limited. (NYSE:SLB) in terms of revenue, lagging by only about 8% to 9%.
On the cost front, the combined operation is expected to generate savings of $1.6 billion by 2020. Most importantly, the deal is expected to be accretive to earnings per share by 4 cents in 2018 and by 8 cents in 2020. Since profits are the mother’s milk of share prices, this is bullish for GE stock.
Thumbs Up for GE Stock
Wall Street was largely positive about the development. Analysts at Bernstein see it as both an offensive and defensive coup. From a note to clients:
“The very short story is 1) these businesses are highly complementary (in products, technologies, services, capabilities) and enable NewCo to compete more effectively with the Schlumberger (SLB)/Halliburton’s (HAL) of the world to meet customer demands … 2) the $1.6B of operational cost and revenue synergies promised by management (plus tax) sounds aggressive to us but is in the realm of the possible; 3) the transaction structure provides General Electric shareholders earlier upside to an upturn in the O&G cycle with limited cash outlay; 4) relative valuation for General Electric seems positive to us given relative position in the up/mid/down-stream cycles; and 5) Big picture, aside from defensive aspects of the move and higher exposure to fossil fuel risk, this cements yet another pillar of the go-forward General Electric portfolio (while pruning orphaned Water). We see this deal offering both defensive and offensive value. We believe General Electric had to put together a deal like this at some point to remain viable in the O&G space.”
If anything, the deal only buttresses the bull case for GE stock. Oil prices have been brutal for a long time now, but that doesn’t mean they’re no longer cyclical. This is a wise bet on the future recovery in energy prices. Other future-looking efforts are likewise appealing. Farther out, General Electric’s investments in software, 3D technologies and other next-gen industrial businesses should pay off eventually. Remember, it wants to be a top 10 software company in a few years.
Meanwhile, the valuation and dividend remain compelling. General Electric stock trades at 17 times forward earnings. That’s not unreasonable for a company with a projected compound annual growth rate of 12%.
Then there’s the dividend, which currently yields an attractive 3.2%. A six-year track record of rising dividends sweetens the deal.
The Baker Hughes news will complicate GE’s earnings picture for the next few quarters and will require extra attention from management. General Electric stock, however, looks like the same solid play for equity income investors.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
