GE Pays Up To Get Into Another Attractive Energy Business

By Stephen D. Simpson, CFA | April 09, 2013 AAA

General Electric (NYSE:GE) is not messing around when it comes to making itself into a leading manufacturer of equipment for the oil and gas industry. Having already established a strong presence for itself in areas like subsea and surface equipment, GE is taking a deeper dive into artificial lifts with its high-priced acquisition of Lufkin Industries (Nasdaq:LUFK).

The Deal to Be
Assuming that the deal goes through as announced, GE will be acquiring Lufkin Industries for $88.50 per share in cash, or $3.3 billion. This deal values the company at about 13.5x the average 2013 EBITDA estimate and 38% above Friday's close.

For that hefty price tag, GE is getting about $1.3 billion in trailing revenue and one of the leading players in rod lift. With the deal, GE will become the second-largest player in artificial lift with about 15% share, and one of the better-diversified players in that market.

SEE: Mergers and Acquisitions: Understanding Takeovers

Why Artificial Lift?
As the name might suggest, artificial lift is an artificial means of improving the flow of liquids out of a well. When reservoirs lack sufficient pressure to push up the desired fluid (oil in this case), producers turn to artificial lift – using rod pumps, electric submersible pumps (ESP), progressive cavity pumps, and other means to get the oil flowing.

Prior to this deal, GE had some share in the ESP market (third largest at about 13% share), and Lufkin was a significant player in rod lift behind Weatherford (NYSE:WFT). While ESP has historically comprised the majority of artificial lift activity, share has been shifting towards rod lift with increased exploitation of unconventional shale and the lower flow volumes of those wells (rod lift is more useful in lower-flow wells).

Combined, the two companies will have about a 15% share in the artificial lift market, still well behind Weatherford's 20%-plus share, but right in the mix with Baker Hughes (NYSE:BHI) and Schlumberger (NYSE:SLB). What's more, the deal will make GE a relatively unusual player in artificial lift with a solid presence in both rod and ESP.

For at least the next three to five years, this looks like an attractive market to target. It costs millions to drill the horizontal wells needed to exploit regions like the Bakken, and it thus behooves the E&P companies to squeeze every profitable drop out of those wells. With that in mind, this market could generate close to $13 billion in sales in 2013, growing at a double-digit rate.

SEE: Guide To Oil and Gas Plays in North America

Competition Seldom Makes Things Better for the Entrenched Players
As a Weatherford shareholder, I can't pretend to be thrilled with this announcement. In fact, I'd held out some hope that GE would come knocking on their door. In any case, while Weatherford will still have strong share in artificial lift (particularly rod), GE has proven itself to be a savvy and strong competitor and I wouldn't rule them out as a share-gainer in the industry. That said, this move is probably more dangerous to other players like Dover (NYSE:DOV) and even smaller companies that have less operating leverage and less overall presence in the market.

The Bottom Line
I don't think Lufkin shareholders can begrudge the price that GE offered. Acquisition multiples in the oil equipment space have been running around 10-12x, and GE certainly paid a premium on top of that. At a minimum, it does back up the idea that there's value in artificial lift and stocks like Weatherford.

SEE: Analyzing An Acquisition Announcement

For GE, this is a pricey deal, but one that I believe can still pay off. The more services and products GE can offer, the more valuable it becomes to larger E&P companies that want to deal with large, well-established companies that can offer a full range of products or services under one roof. That said, it does highlight that the company is keen to grow its energy/commodity businesses and is willing to pay a premium for the companies it wants – a philosophy that does carry the risk of ultimately overpaying for assets in a very cyclical industry.

Disclosure: At the time of writing, Stephen Simpson owned shares of Weatherford.

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