When to buy, when to sell, when to develop internally

Racing to grow - strategically

Among the major service companies, integration has become the watchword. Acquisitions, strategic alliances, and spin-offs are shaping a new generation of "integrated" service companies that reflect the changing prospects and needs of the petroleum industry.

Representatives of three of the world's largest service companies recently discussed their impressions of this business shift, what drives their acquisitions strategy, and why is bigger strategically better.

Weatherford

Weatherford entered the completions business through a swift program of strategic acquisitions. By identifying smaller companies with key technologies, Mark Hopmann, Weatherford's President of Comp-letion Systems, said the company can either fill out an existing product line, or branch out into a critical new area.

For the companies being acquired, Hopmann said there are various advantages to such a deal: access to new markets, the advantage of greater research dollars, and the chance for creative people to see their ideas put into action as part of an integrated product line.

Why consolidate

Hopmann said the recent consolidations in the service industry reflect the challenges oil companies face in exploiting new and existing reservoirs. It is increasingly difficult, and expensive, to develop offshore fields. The fields being discovered are either not as large as those seen in the past or are in greater water depths, increasing the cost of recovery.

In some cases, the oil company is facing a depleted reservoir that requires new technology to further exploit. All of these scenarios require an almost seamless series of services. Every stage of development must be integrated to ensure production is brought on as soon as possible and managed to make the most of each asset. It is simpler for one company to perform these tasks, Hopmann stated.

Such integration also gives the service company an edge in negotiations with the operator. An integrated service company is capable of taking a risk-reward approach to some projects and benefits from the increase production or shorter delivery times it can offer. Such an arrangement only works if the service company has input into the various activities on a project.

In a sense, the advantages to acquisition can be divided along two lines, those that increase a company's scope and those that speed the implementation of new technology. As a service company strives to develop new ideas, it often acquires a smaller company that already holds a key piece of the technology puzzle. This process is much faster and should be cheaper than developing the technology internally. In the process, the company continues to grow. Size is an advantage when competing in markets where infrastructure and support facilities are limited.

Disruptive technology

In this way, size and capabilities seem to go hand in hand. Hopmann said acquisitions offer quick access to what is considered a disruptive technology. Disruptive technology, Hopmann explained, is a new idea that competes with an established way of doing things. A large service company often has a substantial investment in existing technologies. This can make the company reluctant to develop innovations that could conceivably put its existing product line out of business.

Small start-up companies, on the other hand, rely on this type of technology to get their foot in the door. These companies cannot compete as well on a commodity level with the giant service companies, so they must count on upsetting the balance in order to gain access to the market.

Hopmann said the trick is identifying which of these companies is on to something valuable, acquiring them, and making them part of Weatherford, without losing the mindset that developed the disruptive technology. "We need to find (acquisitions) that will shake things up," Hopmann said. He cited expandable sand screens, which are seen by many as a threat to the existing way wells are completed.

Not all acquisitions center around this kind of game-changing technology. Many of the smaller companies that are acquired are simply a good fit for Weatherford. Hopmann said there are always gaps in a service company's product lines. If a small company has made a name for itself as a niche provider in one area, Weather-ford can offer it greater access to markets and the support of a global network.

For Weatherford, this will not only fill a gap in the product line, but provide the key personnel needed to provide these services. With a highly publicized manpower shortage, the industry is always looking for qualified workers - a strategic acquisition provides the people as well as the technology.

Gaining creative potential

To make the most of the creative potential that comes with acquisitions, Hopmann said Weather-ford offers workers incentives for coming up with innovative solutions and involves them in profit sharing to give them a stake in the company. He said that typically very few of the people from an acquired company choose to leave after a Weatherford acquisition.

To ensure these ideas see the light of day, Hopmann said it is important to clear away the bureaucracy and commercialize the new ideas as soon as possible. This is also a good way to offset the cost of an acquisition, he explained.

The advantages for acquisition are clear, but that does not make it the answer in all cases. Hopmann said it is critical that the company being considered not only have a good idea, but an idea that centers around an area of the industry Weatherford can be confident will grow faster than the industry overall. This is the best way to exercise a strategic advantage.

The acquisition must also fit into the existing product line. Acquisitions outside the company's areas of core competency can be risky. Even if the technology proves out, Weatherford would not be equipped to market or support it.

Many of the recent acquisitions by Weather-ford have come out of the North Sea area. Hopmann said there is a reason for this. That market offers small companies funding and support to develop new ideas. Many of the technologies that were originally developed in the North Sea have applications in other markets, but lack access.

In the US, most of the acquisitions are based on market penetration. Weatherford would buy a company that is established in a certain geographic area. This would give Weatherford a foothold in this market and allow it to introduce its other products and services to the same users.

Not every acquisition is successful. Mistakes are inevitable, and Hopmann said it takes a certain amount of risk tolerance to build a company this way. He would like to see nine out of 10 deals become successful. To achieve this ratio, it is necessary to review not only the technology the company is promoting, but the organization as a whole.

In many cases, it is not the company's main product but an ancillary expertise that makes it an attractive target. Again, Hopmann said the acquisition has to be part of Weatherford's strategic plan. This means the new product must fit in with the goals of Weatherford.

Two of the big drivers of consolidation in our industry have been growth and cost reduction. As the number of consolidation targets diminishes, the only way to maintain growth and improve profitablility is through the application of new technology. The application of new technology not only leads to greater efficiency and and lower costs, but improved recovery of reserves in an area where decline rates are accelerating.

Schlumberger

Victor Grijalva, Vice Chairman of Schlum-berger Limited and Chairman of Transocean Sedco Forex, said these companies are no stranger to joint ventures, acquisitions, and spin-offs. Grijalva said the ongoing trend of integrated service companies has been devel-oping over the last 10 years. To compete in the current market and better serve their customers, service companies must pinpoint their areas of expertise and grow their market share. This not only means making acquisitions that enhance the company's core business, but also spinning off segments of the company that don't fit with this vision.

Acquisitions and spin-offs are combined with internally developed technology and joint ventures to allow Schlumberger to sculpt a company that is very competitive in key service areas and provides our customers with a full range of integrated services, Grijalva said. To do this, a company must identify where its core strengths lie. Once this is understood, any acquisitions or spin-offs come naturally.

Shaping a company

One of the strongest examples of how Schlumberger has shaped itself is the spin-off of Sedco Forex. At the time of the decision to merge the drilling company with Transocean, Sedco was bringing in a healthy $1 billion a year in revenue. While the business was profitable, its focus was not fully aligned with the rest of Schlumberger. The spin-off and subsequent combination with Transocean created a company strongly focused on drilling services. Transocean Sedco Forex is now the largest drilling company in the world.

The Schlumberger joint venture with Smith, M-I, is the most efficient drilling fluids company in the world. Together, they are able to focus on the technology and teams needed to efficiently deliver to their clients around the globe.

More recently, Grijalva said, Schlumberger has formed a joint venture with ABB for deepwater well solutions. The new company, Syntheseas, will lead Schlumberger further toward full reservoir optimization by providing the integrated expertise needed for rapid field development, Grijalva said. ABB and Schlumberger together provide knowledge of subsea equipment and intelligent completions, as well as the tools and teams to manage the data and the reservoir. This kind of an integrated program helps operators get the most out of each well, bringing production on line sooner and extracting more hydrocarbons from the reservoir.

Grijalva said Schlumberger also likes to make acquisitions, where appropriate, to fill-out its range of services. This can be seen in the acquisitions of GeoQuest and Merak for software and data management, the acquisition of Camco for expertise in submersible pumping systems and gas lift technology, and more recently, the purchase of Sensa for innovative fiber-optic technology. These acquisitions are a quick way to move to the head of the pack, but the advantages reach much further.

Corporate culture

Schlumberger doesn't buy a company that is not technologically or culturally a good fit. Corporate culture, business ethics, and technology all need to mesh. Before agreeing to an acquisition, Schlum-berger researches a company's history and examines key elements to determine if it would be a good mix with Schlumberger. Schlumberger believes that the people are the most critical element. After all, if the company is going to operate under the Schlumberger name, top quality and teamwork are essential. Once a decision is made to pursue an acquisition, integration teams are formed with representatives from both companies. "It is an in-depth joint integration team that performs this analysis," Grijalva said.

Employees who join Schlumberger through such arrangements are fully part of the Schlumberger team. They become Schlumberger employees, with the same benefits and career opportunities as any other employees. Schlum-berger's experience in integrating new companies not only completes the product and service offerings, it has allowed many motivated employees to broaden their careers and experiences over the long-term.

Halliburton

Halliburton sees its role as directly supporting the companies exploring for energy and providing retail energy products - meaning the company is involved in the entire lifecycle of oil and gas. Gary Morrison, Executive Vice President of Halliburton, said the company targets acquisitions that fill the small holes that still exist along this life cycle chain.

He said it is rare that an entire new company surfaces as a potential acquisition. Most of the companies interested in being acquired have been "shopped around" and are already known to Halliburton. The company maintains an aggressive research and development program to generate new products and services for its markets. When it appears that R&D may not deliver the needed solution quickly enough, the company turns to the acquisition arena. In general, the company identifies a need and then seeks an acquisition that fills it. For example, Morrison said the acquisition of Landmark Graphics gave Halliburton access to technology and services it did not provide in house.

Further consolidation

While there are a number of potential acquisitions underway at any time, Morrison said that from a big picture standpoint, there is still room for consolidation among the major service companies. He points to the giant deals that have been made among the major oil companies. Mergers such as BP Amoco, Exxon Mobil, and Total-FinaElf, show that even very large companies can profit from the efficiencies of consolidation.

Larger oil and gas operators make greater demands of their service companies. To compete means a service company must itself be very large. There is a lot of expenditure up front on large projects. If a service company can't cover these risks, it can't compete, Morrison said.

He cited the Barracuda project offshore Brazil as an example. Halliburton was signed as lead contractor on this $2.5 billion project. Only a very few service companies could even bid on something this large. Opportunities still exist for smaller contractors, Morrison said, but these companies have to split up the risk, meaning they cannot take on the whole project themselves. It would be impossible for a small company to gain access to the capital needed to pull off something like Barracuda. "We can do that because of the breadth of our technologies, strong balance sheet and our global infrastructure of people and equipment," Morrison said.

Integrated services

There are a lot of billion-dollar projects in the works right now. To compete for these requires size; and with size comes integration of services. This is a big plus for Halliburton, Morrison said, but is not the only consideration. In many cases, the oil and gas producer doesn't want one contractor providing all the services on a project. "The bulk of the work will be discreet service work," Morrison said.

The major benefit of being an integrated service company is that all of the service providers in the organization understand where their service fits in to the scheme of things. This allows the services provided by Halliburton to mesh with other internal services and those provided by other service companies.

While Halliburton is always on the alert for acquisition targets, Morrison said the company has clearly defined boundaries. Halliburton is not interested in becoming involved in drilling rigs, or floating production, but its involvement in subsea systems will be growing. Some services are simply not necessary for Halliburton to own, Morrison said. Others, such as data management, can be handled through smaller acquisitions, like the recent purchase of Magic Earth.

Halliburton took notice when Magic Earth's data management products came on the market. Morrison said Halliburton watched this technology company grow and when the time was right, moved to acquire it. This company's product fits well with the data analysis capabilities of Landmark, Morrison said.

In most cases, when Halliburton is considering an acquisition, there are a half dozen or so companies that provide the desired service or technology. Once these are identified, it becomes a matter of determining which would be the best fit for Halliburton. A key factors in this determination is the achievement of the two companies - Halliburton and acquired company - together.

Shareholder value

In addition to finding the company that would benefit the most from joining Halliburton, Morrison said the acquired company must provide shareholder value in the short term. He gives the example of the Dresser merger. Halliburton was looking for people and resources that would enhance its capacity going into the boom of early 1998. Although this flurry of activity was short lived, this was a strong driver in the acquisition.

Dresser's engineering and construction capabilities were a nice fit with Brown & Root's construction management capabilities, and Dresser gave Halliburton an entry into the drill bit and fluids areas of the business.

This $9 billion deal was probably the last of its kind, but Morrison insists there are still a number of $3-5 billion opportunities out there, although most of the acquisitions Halliburton will make in the near future will be in the $100-500 million range. Also, while size is an advantage for Halliburton, Morrison said there are some breakthrough technologies that only small companies will develop. These always make good acquisition targets.

In terms of spinning companies off, Morrison said Wall Street plays a role in these decisions. Investors tend to favor "pure play" companies, rather than those involved in too many aspects of the business. Analysts do not always like companies that are blended together in a merger.

If Halliburton feels an acquired company has some capabilities that would perform better as an outside company, this could lead to a spin-off or a sale.

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