Where Will Baker Hughes Be in a Year?

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Baker Hughes, a GE Company (NYSE: BHGE) is the combination of old Baker Hughes with General Electric's (NYSE: GE) oil and gas division. That somewhat complicated merger-and-spinoff deal was completed in 2017 and is still a work in progress. Over the next year or so, Baker Hughes will continue to focus on integration efforts. However, there's still one big overhang that isn't going away so soon.

A lot of work to do

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Baker Hughes and GE's oil and gas division were large players in the energy services business as stand-alone entities. Together they are, obviously, even bigger, offering a solution set that the combined company likes to describe as "fullstream." That means it can step in to help companies across the energy value chain, from upstream drilling activities (around 60% of revenues) through the midstream assets (25%), like pipelines, that move oil and gas, and all the way to the downstream businesses (5%) that refine them into usable products like gasoline and chemicals ("other" makes up the remainder of revenues).

To be fair, it's a compelling combination. But integrating two giant businesses, both of which were struggling in a weak market at the time of the merger/spinoff deal, isn't an easy process. It's also not a quick one. For example, Baker Hughes was able to implement roughly $800 million in synergies in 2018. That's a mixture of cost savings and revenue enhancement. But that's just a down payment.

In 2019, management's goal is for $1.2 billion in synergies. It's looking for $1 billion in cost savings, with the rest coming from the revenue side. In 2020, the synergy goal jumps to $1.6 billion, made up of $1.2 billion in cost savings and the rest from revenue enhancements. The merger has been completed, but the integration process is certainly not done yet.

Luckily for Baker Hughes, its business has started to stabilize a bit, which should make hitting its goals a little easier. On that front, revenues were up 5% in 2018 with a 10% increase in orders. And while the first quarter of 2019 was mixed, with revenues and orders down sequentially from the fourth quarter but up year over year, Baker Hughes appears to be on the right course operationally. So the next year or two should bring continued improvement on the operations front.

What a drag

That said, there's another issue that is going to linger...potentially for years. And that's General Electric's ownership interest in Baker Hughes. In the fourth quarter of 2018, the two companies agreed to a deal in which GE would continue to provide key services to Baker Hughes and sell down its ownership interest to raise much-needed cash for the struggling industrial conglomerate. That quarter saw a reduction in GE's position from 62.5% ownership to 50.4%. Some market watchers have suggested that GE's desire to reduce its stake here is potentially a desperate move.

The problem is that 50% is still a very large number, with no further reductions in GE's stake made during the first quarter. But GE has now inked a deal to sell a part of its healthcare division to Danaher. That $21 billion sale will give GE a material amount of breathing room and, perhaps, reduce its need to quickly trim its position in Baker Hughes. That's both good and bad. For GE, it means it can wait for better pricing (reducing the desperation quotient), but it also means Baker Hughes may have to deal with the overhang of stock that's just waiting to hit the market for longer than it might like.

Even if you assume the stock sales are handled well, it is hard to believe that there will be no effect on the stock price. Every time GE starts selling shares, it will act as a restraint on potential stock increases, since the shares GE disposes of will sate market demand for the stock. Or, worse, sales could exacerbate stock declines if there are more shares hitting the market than investors generally want to buy. So even if Baker Hughes continues to execute well, there's no reason to get too excited here, because GE's ownership interest remains a complicating factor.

No material change on tap

Assuming there is no material downturn in the oil and gas industry in 2019 (a big assumption in the often-volatile energy sector), Baker Hughes should perform reasonably well over the next year or so, financially speaking. That will likely include continued improvement on the integration front. But what is unlikely to change in a material way is GE's large ownership stake -- it's hard to jettison that much stock in 12 short months without having a severely negative impact. Which is why most investors are probably better off avoiding Baker Hughes until it has finally untangled itself from General Electric.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.