On Thanksgiving Day in 1966, Las Vegas welcomed a wealthy, enigmatic, and reclusive visitor.
The businessman, aviator, film fanatic, and multi-billionaire Howard Hughes Jr. arrived by train and moved himself into the Desert Inn.
After a few months of complaints from the owners of the hotel that he wouldn’t leave, Hughes, in true billionaire spirit, fixed all problems and bought the hotel outright.
For the next nine years, he lived in the penthouse on the ninth floor and used the eighth floor as his business headquarters.
Like wealthy businessmen are wont to do, Hughes started buying hotels and casinos… From Castaways to the Landmark and the Sands, he flexed control over the desert territory like none other.
And it was all possible not just because of his business acumen but also because of the tremendous wealth left to him by his father, Howard Hughes Sr.
In 1909, Poppa Hughes started the Hughes Tool Co. after he developed and patented the two-cone roller bit that allowed oil drillers to break through tougher rocks and access previously off-limits oil and gas.
The Hughes Tool Co. went on to make a fortune for father and eventually son, who used the money for philanthropic exploits, aviation, medical research, and, yes, Vegas casinos.
These days, the Hughes Tool Co. is still thriving, albeit under a different name…
The Next Merger in Oil Services is Huge
In 1987, Hughes’ company merged with Baker International and became what’s still known today as Baker Hughes International (NYSE: BHI).
The company is valued at $25 billion and provides services to oil drillers such as drill bits and other heavy equipment meant to make the process of oil extraction more profitable.
Last Thursday, Halliburton (NYSE: HAL), another major oil services player, was reported to be in talks to buy Baker Hughes.
Although details of the deal are still murky, many have speculated that it would be one of the biggest deals ever, bringing together two of the oldest and largest firms in the United States.
With the purchase of Baker Hughes, Halliburton would gain the company’s coveted oil tools business and its technology for boosting production from older wells.
Thus Halliburton could diversify its oil services portfolio beyond fracking technology and the well-cement processes for which it was created in the early 20th century.
By merging into one giant conglomerate, the second- and third-largest oil service providers would chip away at the larger market share held by top dog Schlumberger (NYSE: SLB).
And although the deal would only give the combined companies half the value of the $125 billion Schlumberger is worth… there are still major advantages.
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Timing is Everything
With oil prices hitting lows not seen since 2010, some oil services firms worry they will be forced to cut prices to drillers and miss profit expectations.
But the prospective deal will hedge against this by merging and diversifying the services both companies offer.
As my colleague Keith Kohl pointed out on Friday, the decline in oil prices can be directly attributed to the growth of U.S. oil supply from shale.
And by combining, Baker Hughes and Halliburton would control about 40% of the $25 billion U.S. fracking services market. That’s more than double Schlumberger’s presence in U.S. shale.
Plus, the oil bear market has sent the stocks of both companies lower during the last four months, so now is the only time for Halliburton to put in an offer, since cheaper shares offer more leverage in negotiations.
As this bear market takes its toll on oil stocks, the companies themselves still clearly see the value of buying in the down market…
And if you read these pages regularly, you know we do, too.
In fact, in an essay about Schlumberger a couple of weeks ago, I mentioned that the slump for oil services firms offered a nice opportunity to buy shares on the cheap.
The Market Vectors Oil Services ETF (NYSE: OIH) is floating well below its potential value and could offer great returns over the next few months, and perhaps even longer.
The ETF holds Baker Hughes, Halliburton, and Schlumberger among a host of other oil services firms.
Now that investors are looking more closely at a typically under-hyped industry, the next few months of anti-trust and price negotiations between the two firms could generate enough attention to send services stocks higher.
Good Investing,
Alex Martinelli
With an eye squarely focused on the long-term, Alex Martinelli takes the art of income investing to a higher level within the energy sector. His research has helped hundreds of thousands of individual investors identify well established companies that have a long history of paying out dividends to their shareholders. For more info on Alex, check out his editor’s page.
