General Electric Moves Into The Oil Services Industry

by Tony D'Altorio

General Electric Moves Into The Oil Services Industry

by Tony D'Altorio, Investment U Research

Tuesday, February 22, 2011

General Electric (NYSE: GE)'s $228 billion market cap makes it the largest U.S. manufacturer, as measured by market capitalization.

After its problems during the financial crisis, the conglomerate had to reshuffle its portfolio. GE sold off many of its entertainment assets, reduced its dependence on its financial arm and strengthened its position in industrial markets.

Now GE is trying to strengthen its manufacturing operations by broadening its energy business.

In the past, that particular arm was heavily dependent on U.S. turbine sales. But the company is now on a spending spree in the oil services.

  • It started in October, when GE paid $3 billion for Dresser, which makes engines, pumps and valves for the oil and gas industry.
  • Two months later, it shelled out $1.2 billion for Wellstream, a British oil drilling pipe company.
  • Now, GE is paying $2.8 billion for part of another British oil services firm, Wood Group (PINK: WDGJF). The division makes submersible pumps and equipment for controlling and monitoring oil and gas wells.

GE's M&A of The Wood Group

The products made by The Wood Group are used for squeezing hydrocarbons out of mature fields. And they also help in the removal of natural gas from "unconventional" fields, such as shale.

It seems fair to question whether GE paid too much to acquire the Wood Group business.

The company can afford it, of course; it did have $19 billion spare cash at the end of 2010. It just needs to demonstrate that its oil drilling and production support business will justify the capital commitment.

Still, it did pay a lot for the well-support division, in order to discourage the competition. That included Halliburton (NYSE: HAL), Cameron International (NYSE: CAM) and Weatherford International (NYSE: WFT).

The final price tag costs about 17 times last year's earnings before interest, tax, depreciation and amortization (ebitda) of $166 million. And it's 14 times the $200 million ebitda expected this year.

  • In comparison, GE's Wellstream purchase was roughly 13 times ebitda.
  • And the $11 billion takeover of Smith International by oil services giant Schlumberger (NYSE: SLB) last year was only 11 times it.

But the Wood Group might actually deserve that premium. Its electric submersible pumps generate about half the division's revenues, with a strong position in an increasingly important market segment that squeezes extra oil out of aging fields.

Shale Natural Gas and The Oil Industry

About two-thirds of the world's oil comes from just 300 giant fields. But what most people don't know is that only a third of that is easily accessible.

Any extra oil obtained from those fields is critical to global supplies. So investing in the machinery involved in such ventures is a smart move... especially compared to trying to discover a new supply.

Most of the division's remaining revenues come from pressure control valves for oil and gas wells. Those are broadly used in the fast-growing shale natural gas sector of the energy industry.

In the U.S., the unconventional natural gas business is booming, and expects to invest another $40 billion to $60 billion over the next five or six years. Meanwhile, China and parts of Europe, like Poland, show potential too.

In other words, based on the state of the oil industry, the Wood Group purchase looks like a good one.

GE Now a Major Oil Services Player

Current trends also make General Electric's pricey decision look good. The oil industry expects the global oil services market to be worth $500 billion this year, growing another 15% in 2012.

GE's recent purchases have transformed it into a major player in that sector, with annual revenues of about $5 billion a year.

John Krenicki, CEO of GE's energy division had this to say: "Five years ago, our revenues from oil and gas drilling and production equipment were zero. Now, out of nowhere, we are a force to be reckoned with."

That showed clearly last year, when the company won several contracts to support building the massive $45 billion Gorgon LNG project. It acquired those deals for the Chevron (NYSE: CVX)-led venture off the northwest coast of Australia well before any of the others.

GE just has to show it can execute its goals now. But as it does, look for it to win many other major oil service contracts in the near future.

General Electric intends to become a big player in the field. And it has the means to do just that.

Good investing,

Tony D'Altorio

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