Citigroup: General Electric-Baker Hughes Deal Valuation Appears ‘Reasonable’


After examining the agreement between General Electric (GE) and Baker Hughes (BHI), Citigroup’sAndrew Kaplowitz andScott Gruber contend the “deal valuation/mechanics look reasonable.” They explain why:

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GE/Baker Hughes deal seems like it strikes a good balance for GE and Baker Hughes bulls. General Electric is not selling at the bottom, valuation seems fair for Baker Hughes shareholders, and General Electric management retains control to roll out its Digital/Service focus across a much broader oil and gas platform. With GEs stake representing 62.5% of the combined company, we think the transaction gives GE shareholders exposure to a better positioned oil and gas equipment/services business with substantial runway for earnings growth even in only a modest market recovery. We do note that BHIs stock is weaker today, likely given concerns that General Electricss non-cash contribution to the deal (in the form of 37.5% of GE oil and gas) doesnt provide enough value to Baker Hughes shareholders we think that concern will diminish over time given the improved competitive and cost position we see of the combined company.


Deal valuation/mechanics look reasonable. We do think General Electric is underwriting at least a modest oil and gas upturn going forward, but deal valuation looks reasonable to us and synergies could be substantial. 2018 EV/EBITDA at ~11x seems reasonable in the context of oil services comps trading at 12x and we do think General Electrics improving cost-out focus over the last couple of years should allow the company to harness realistic procurement and SG&A. As such, a targeted $1.2bn of synergies through 2020 on an implied ~$27bn cost base, does not seem overly optimistic and we think, with good execution, should be achievable. We note too that General Electric announced plans to sell its water business, with an expected ~$1bn gain on the eventual sale used to offset the costs of achieving synergies. Given that we had viewed Water as of diminishing importance within the overall General Electric portfolio, we view GEs planned exit as further focusing the overall portfolio around businesses that can fully leverage General Electrics growing Digital capabilities and the GE Store. Time will tell if revenue and market share gains will materialize, but only $400mn of revenue synergies on $24bn of 2016 revenue seems like a low bar to meet. With GE contributing $7.4bn in cash in addition to its Oil & Gas business, the transaction reflects deployment of a meaningful portion of the ~$20bn in incremental leverage GE had noted as available for transactions over the next few years, but given a reasonable valuation and that we think the deal enhances General Electrics visibility to EPS growth over the next several years, shareholders could view the deal favorably.


Kaplowitz and Gruber also provided a handy table breaking down the deal math, which puts the premium paid to Baker Hughes at about 17%:

Share of General Electric have declined 0.1% to $29.18 at 2:52 p.m. today, while Baker Hughes has tumbled 7.6% to$54.60.

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