Research Insights and the
Halliburton-Baker Hughes Merger
An In-Depth Q&A with Gustavo Grullon and Vikas Mittal
Interviewed by M. Yvonne Taylor
Conventional business wisdom states that
mergers make business sense. Merging firms
can cut costs by reducing redundancies and
consolidating operations, expanding their scope
and market share, and freeing up capital for further growth.
Last November, Halliburton and Baker Hughes, the second
and third largest oilfield services firms in the world decided
to merge. According to Halliburton, the deal, the biggest
takeover of a U.S. energy company in three years, will
consolidate operations, provide cost savings and align and
expand their customer base. Halliburton’s CEO Dave Lesar has
said that the merger could save the merged entity as much
as $2 billion a year. And with lower oil prices and mounting
pressures on margins, such a merger may make even more
sense. But despite the many opportunities for business
success, mergers are complicated and risky business.
Among their many offerings, both companies provide drilling
and hydraulic fracturing services to a large customer base
of oil and natural gas companies. Providing these services
requires a combination of capabilities, such as technological
innovation, operational support to customers, after-sales
service and so forth. On the one hand, Baker Hughes has
the innovative products and technological know-how to
drill new wells and boost production in older wells. On the
other, Halliburton is well-known for its capacity for efficient
execution and logistics management.
But integrating these capabilities requires agreement and
collaboration at all levels of both merging companies —
from the highest levels of company leadership to front-line
managers and employees. The sheer size of these two entities
may also introduce additional complications because of the
global footprint of the customer base of both companies and
potential antitrust issues. In fact, the regulatory risks involved
are so weighty that Halliburton offered Baker Hughes a $3.5
billion fee if the deal fails to go through due to failure to gain
So what can research tell us?
Vikas Mittal, head of the Jones School’s Energy Initiative and J.
Hugh Leidtke Professor of Marketing, and Professor of Finance
Gustavo Grullon, sat down recently to discuss how their wideranging
research on customer focus, efficiency of financial
markets and strategic thinking can inform one of the most
discussed merger stories in the energy industry.
Who benefits from value creation in a merger: target
or acquiring firm?
Grullon: If you look at the empirical evidence, mergers,
on average, do create value. The problem is that most of
this value is captured by the target firm, not the acquiring
firm. In many cases, especially during a large merger, the
acquiring firm experiences negative stock returns around the
announcement of the merger. Value is created by combining
two firms, but most of it goes to the target firm.
[This can be seen in stock prices for both Halliburton and Baker
Hughes, immediately following the merger announcement.
On November 17, the day of the announcement, Halliburton’s
stock price fell 11 percent to $49.23, their biggest decline since
June 2010; Baker Hughes’ rose 31 percent more than its price
three days prior. General market reaction to the merger news
overall has been mixed.]
Grullon: Industry concentration is also a relevant issue
during M&A transactions. My recent research shows that in
industries with fewer rivals, acquiring firms tend to get better
value from the deal. You see more value creation for acquirers
in those cases where there is less competition in their product
market. This evidence is particularly interesting because it
suggests that market power considerations are becoming a
key source of value during these corporate events. We also
know from previous studies that when public firms buy
private firms, usually the acquiring firms tend to do better in
those transactions. One potential reason for this phenomenon
is that public firms have more negotiating power in private
transactions than in public ones. In addition to this, there is
evidence that expected synergies are more likely to be realized
in smaller deals than in bigger deals. Big deals are so complex
that they usually end up destroying value.
How can value be created in a merger: efficiency
focus or revenue-enhancement focus?
Mittal: Firms tread a delicate balance — you can save cash
through a relentless focus on efficiency or generate cash by
enhancing revenues from your customers. We found in our
research that, post-merger, only firms that simultaneously
create efficiencies and create revenue enhancement (through
increased customer satisfaction) were the ones that increase
value in the long run. In other words, achieving a dual focus
— creating efficiencies and enhancing revenues through
customer satisfaction — is what led to superior long-term
value for merging firms.
Can a dual emphasis be achieved? Yes, but only with a
relentless eye toward implementation. For example, take the
case of the US Airways and American Airlines merger.
It’s been almost a year but they are still working to integrate
their reservation systems. They had eight hub airports; five
from American and three from US Airways. And they’re
still in the process of getting an agreement signed with the
employees. So the big things that could have created any value
from the customers’ point of view — good customer service
because of happy employees or a good reservation system —
haven’t materialized due to implementation issues.
What about capital expenditures in mergers?
Carefully reducing them pays off.
Grullon: There is evidence that most of the synergies in M&A
transactions come from the elimination of duplicate activities
and reduction in capital expenditures. These types of synergies
are extremely important in the oil and gas industry. So one way
you could see a benefit from the Halliburton-Baker Hughes deal
is through reduced capital expenditures, and that could have a
huge impact on current cash flows. However, managers need to
be careful because these decisions can have a significant impact
on the long-run performance of the firm. While reducing capital
expenditures can increase cash flows in the short-run, it could
hurt the ability of the firm to grow in the future.
Mittal: That’s a good point. The reduction of capital
expenditure must be done very carefully. When it’s reduced in
more of a surgical manner, very strategically — not reducing
capital expenditure just for the sake of reducing capital
expenditure — there’s a lot of potential.
There’s a second piece coming into play for the HalliburtonBaker
Hughes merger. With the downward pressure on the
price of oil, many E&P companies are reducing their capital
expenditures. In anticipation of weak 2015 commodity prices,
ConocoPhillips has further reduced its expected 2015 capital
expenditures to $11.5 billion from the $13.5 billion previously
announced. Shell announced that it would cut spending
by $15 billion over the next three years. BP announced a 20
percent cut in spending this year. Chevron intends to spend
$35 billion in capital in 2015 versus the $40 billion it spent in
2014, a 20 percent cut. ExxonMobil intends to cut spending by
12 percent this year. And the list goes on.
And that can be a boon for companies like Halliburton. The
E&P companies are not going to indiscriminately cut down
any project. They are going to rank order the projects and cut
down the low-grade projects and keep only the high-grade
projects. A lot of these high-grade projects are by default very
complicated. Because of the higher cost of executing these
complicated projects, larger companies are going to look for
more service from the oil field services companies. They are
not just looking to buy a piece of equipment — rather, they are
looking for a complete, bundled solution from a company. A
company like Halliburton which can provide the entire suite
of products, services, advice and assurance is more likely to
Moreover, if companies can innovate and provide that complete
solution are they also more likely to have pricing power. Only
those companies that have pricing power and the scale to
provide the entire array of solutions would have an advantage.
If Baker Hughes and Halliburton can combine resources
judiciously, they should be able to better capture value from
customers, and they’d also have better pricing power now.
Are mergers detrimental to customers? Not
necessarily, as they can stimulate innovation.
Grullon: So related to this issue of pricing power — there is
another side of M&A transactions, which is antitrust issues.
One obvious consequence of mergers in an industry is fewer
firms in that industry. I’m currently working on a paper
where we’re finding very strong evidence that competition
has been declining over the last 15 years. For instance, today
we have fewer public firms than we had in 1973.
Mittal: One way to think about this issue is as follows: a lot of
literature shows smaller firms are more innovative than their
larger rivals. If a wave of mergers leaves fewer smaller firms
in an industry, you’re likely to see a decline in innovation.
Even if you look at the oil and gas industry, particularly the
unconventional industry, a lot of innovation — technological
and process — came from smaller companies. With M&As,
a strategic challenge confronting the oil-field services
companies will be to keep innovating. If they are unable to
innovate they will lose pricing power.
Grullon: Another way to look at this issue is as follows: larger
companies have more resources to deploy into innovation.
They can also sustain, over time, the erratic ebbs and flows of
innovation success. Clearly, the scale of Google and Apple has
enabled them to be more, not less innovative. The resource
constraints in smaller firms do not allow them to have the
same kind of innovation as big firms do. Today, because of the
complexity involved in innovating, it's really hard to innovate
at a smaller scale. You can't do innovation in a garage like
Apple did decades ago. The complexity of the technology is
changing so much it's really hard to do it with a small group
of people. You need not only the resources, but also a team
who can create more innovation.
I'm working on a paper that looks at the effect of competition
on patents. If you look at the '80s and the early '90s, you'll see
that most of the patents were created in competitive markets
— now we are seeing the opposite, that most of the patents
are created in concentrated markets where you have fewer
players. And that may be driven by the fact that now you need
more resources to innovate. And not only that, what we're
seeing is that if a small firm creates innovation, these firms
are likely to be acquired by large firms.
Mittal: Great point. Industries have evolved to address these
issues. I look at pharmaceuticals, which is an industry with
many parallels with the oil and gas industry. That industry
has evolved an eco-system where the smaller companies
innovate, and large pharma typically buys out the small
companies at the commercialization stage.
Really large companies like Google nurture innovation inside.
So, Professor Grullon’s point about resources is well taken.
Inside large companies with resources, you've got to create
processes — whether they are based on incentive alignment
or through company culture — to propel innovation.
In this industry, innovation is extremely important. The
larger problem facing the industry is falling oil prices. The
cost of extracting oil is higher than the price of oil. The only
way to lower the cost of extracting oil is through innovation.
Innovation, in the oil-field services industry has a twofold
advantage. One is that innovation can allow you to lower your
own fixed and variable costs. You make this investment today
and innovation can allow you to lower your cost structure.
And it also allows you to increase pricing power. But the fixed
cost of innovating is high. The lead time to commercialize
innovation is long. And there are enough safety concerns
around every innovation, regulatory approvals, etc. that you
really need an infrastructure to innovate and commercialize
technology, assess their business and financial impact, and
understand their strategic significance. You have to have
people within the organization with commercial acumen
and leadership potential who can take on this task. And that's
how you can profit in the long run.
Oil and gas industry: Any predictions?
Grullon: We may actually see more M&A transactions
because oil prices will drive a lot of consolidations. Cashstrapped
companies are going to look for firms with more
resources in order to survive. So now is going to be a good time
for the big firms to buy the cash-strapped companies because
they are going to have more power on the negotiation table.
Mittal: I agree completely. If you look back to the financial
crisis faced by the U.S. in 2007-08, there was a wave of mergers
— National City, Wachovia, Merrill Lynch — all marquee firms.
However, they were relatively weak, and merged with rivals.
Despite the shock, the financial services sector has emerged
stronger today. In the long run, these types of shocks make any
industry stronger. The oil and gas industry is no exception.
Grullon: Yes, because it drives innovation.
Mittal: It also clears out the weaker players.
Professor of Finance
Grullon currently teaches courses on mergers and
acquisitions and on corporate financial policy.
His research covers topics in empirical corporate
finance and provides rational explanations to
several documented anomalies in the asset-pricing
literature, such as the tendency of investors to
buy familiar stocks and the effect of managerial
flexibility on firm value. His papers have been
published in top academic journals and featured
in the popular press. He received the Jones School’s
Award for Scholarship Excellence in 2006. Grullon
received his Ph.D. in finance from Cornell University.
Grullon, Gustavo, Yelena Larkin, and Roni Michaely.
“The Disappearance of Public Firms and the
Changing Nature of U.S. Industries” working paper
J. Hugh Liedtke Professor of Marketing
Head, Energy Initiative
Mittal’s varied experience designing integrated,
experiential courses along with his superb, multidisciplinary
research record provide the foundation
for a strong, cross-functional energy initiative.
His unique expertise and approach to teaching
core content is embraced by leaders in the energy
industry through courses designed for companies
such as Shell, BP, National Oilwell Varco, Cameron
and CB&I. In 2006, he was awarded the William
F. O’Dell Award in recognition of his significant,
long-term contributions to the theory, methodology
and practice of marketing. He co-authored the new
energy-focused SCOPE survey (see more on p. 8).
Mittal received his Ph.D. from Temple University.
Mittal, Vikas, and Wagner A. Kamakura.
"Satisfaction, repurchase intent, and repurchase
behavior: Investigating the moderating effect of
customer characteristics." Journal of Marketing
Research 38.1 (2001): 131-142.
Mittal, Vikas, Eugene W. Anderson, Akin Sayrak,
and Pandu Tadikamalla. "Dual emphasis and
the long-term financial impact of customer
satisfaction." Marketing Science 24, no. 4 (2005):
Swaminathan, Vanitha, Christopher Groening,
Vikas Mittal, and Felipe Thomaz. "How achieving
the dual goal of customer satisfaction and
efficiency in mergers affects a firm’s long-term
financial performance." Journal of Service Research
17, no. 2 (2014): 182-194.
This article is from the Spring 2015 issue of Jones Journal