Recently, General Electric announced that it would acquire Lufkin Industries at around $88.50 per share, with a total transaction value of around $3 billion. The price represented a whopping 38% premium to its pre-acquisition trading price. General Electric CEO, Jeff Immelt, commented that the company would focus its business on energy-rich shale assets in several areas in the U.S., including North Dakota and Texas.
Since the beginning of the year, General Electric has experienced a decent rise of 10.5%. Is General Electric a buy after the Lufkin deal? Is a $3 billion price a fair value for Lufkin? Let’s find out.
Lufkin, founded in 1902, is a worldwide provider of artificial lift products, automated control equipment, power transmission products for the oil & gas industry, energy infrastructure, and industrial applications, operating two business segments: Oilfield and Power Transmission.
The majority of its revenue, more than $1 billion, or 78.1% of total 2012 revenue, was generated from the Oilfield segment, while the Power Transmission segment contributed around $205 million in revenue in 2012. Lufkin derived most of its revenue from the U.S., with nearly $823.5 million coming from the region. Canada ranked second, contributing nearly $157.3 million in revenue. The company seems to have quite a diverse customer base, with no single customer accounting more than 10% of the total revenue in the past three years.
Growing artificial lift market
The artificial lift market has experienced tremendous growth over the last seven years. Its total market expanded from more than $4 billion in 2005 to around $11 billion in 2012. In 2012, the artificial lift market had a year-over-year growth of 23% compared to 2011, and it would be expected to grow 18% to nearly $13 billion in 2013. Lufkin estimated that the average annual growth of the total market is around 15%-25%.
The leading player in the artificial lift market is Weatherford International , accounting for 24% of the total market. The company reported that it ranked fourth in the global artificial lift market, with a 10% market share. General Electric, with only 5% market share, stands seventh. By acquiring Lufkin, GE would automatically take over around 15% of the total artificial lift market. Daniel Heintzelman, General Electric's Oil & Gas chief, commented that the deal would round out its portfolio with Lufkin’s great brand in the marketplace.
Lufkin’s valuation is high but GE’s valuation is much higher
As Lufkin generated around $195.4 million in EBITDA in the past twelve months, GE seems to value Lufkin high, at around 12.4 times EV/EBITDA, a much higher valuation that the industry market leader, Weatherford. Weatherford is trading around $13 per share, with a total market cap of more than $9.9 billion. Weatherford is valued much cheaper by the market, at only 7.2 times EV/EBITDA. However, the valuation seems to be sweet when we compared it to GE’s own valuation. At $23 per share, GE is the giant with $239 billion in total market cap. The market values GE quite expensively, at around 19.9 times EV/EBITDA.
It seems like Lufkin deserves a higher valuation than Weatherford due to Lufkin’s higher profitability. Lufkin generates a higher operating margin at 12%, while Weatherford’s operating margin is only 7.6%. While Lufkin produces around 7.4% return on invested capital, Weatherford is generating losses. Thus, its return on invested capital is negative at more than 7%. Lufkin is also less leveraged than Weatherford. Weatherford’s debt/equity ratio is 0.8, whereas Lufkin’s debt/equity ratio is only 0.4.
GE will keep making acquisitions
General Electric has been on a buying spree, backing by its huge cash pile of nearly $126 billion. The big corporation seems to focus on the oil/gas sector. In October 2010, it bought Dresser, an oilfield equipment maker, for around $3 billion. Two months later, it agreed to acquire Wellstream, a manufacturer of flexible pipeline systems for the oil & gas industry at a cost of $1.3 billion. In 2011, GE also purchased the oil/gas extraction unit of John Wood for around $2.8 billion. Even with a hefty valuation, investors still get a sweet 3.3% dividend yield from GE at its current price.
My Foolish take
Both Lufkin and General Electric investors should celebrate. Lufkin investors could get out at a double-digit EV multiple while GE could buy Lufkin at a much lower valuation than its own valuation. Indeed, General Electric could be considered a long-term holding for long-term and income investors.
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