HAL Halliburton Co

By Spencer Jakab 

If there is one economic concept an oil man intuitively grasps, it is sunk costs.

Just as Halliburton boss David Lesar would advise clients to walk away from a likely dry hole rather than pour good money after bad, he pushed only as hard as was prudent to complete a merger with rival Baker Hughes, a deal that ultimately fell apart. The result: This week he will be writing that company a $3.5 billion check.

The stock market doesn't seem to mind. On a weak day for oil-field-service stocks, shares of both Halliburton, the intended acquirer, and Baker Hughes, the target, gained in early trading.

The fact that Halliburton didn't sink reflects that investors long ago assigned scant odds to a successful deal. That was due to given regulatory objections on both sides of the Atlantic. Halliburton has the cash and, while the fee stings, it isn't facing distress. Its shares actually did far better than the recipient of its huge check.

Meanwhile, Baker Hughes may be awaiting a sum equal to about 16% of its market value, but the failed merger took a hefty toll on it. That highlights another economic concept: opportunity costs matter just as much as direct ones.

During its first-quarter results last week, the company said it was carrying $110 million of costs during the period that it might have otherwise shed. The anticipated deal was the reason it didn't do so. It also incurred some $306 million in after-tax merger-related expenses in 2015 and the first quarter of 2016.

Finally, Baker Hughes has allowed potential investment opportunities in a distressed industry to pass it by. The $2.5 billion or so in after-tax value it will realize from the break fee it will get from Halliburton shouldn't really be viewed as an outright windfall.

Granted, it does help. Rather than a complicated cost-benefit analysis, the stock market's verdict on the failed merger's impact on Baker Hughes shareholders is telling. The stock is just 6% lower than just before the deal's announcement in November 2014. An exchange-traded fund tracking the sector has shed 31% of its value since then.

Baker Hughes wasted no time in telling investors how it would deploy the cash after paying Uncle Sam: $1.5 billion in share buybacks and $1 billion in debt reduction. It might have been able to buy a smaller competitor such as an offshore driller with little overlap and few regulatory complications. Instead, it is putting its cash into something it knows best: itself.

Investors seeking one of the few companies in the industry with fat left to trim and a healthy balance sheet could do worse than to follow management's lead.

(END) Dow Jones Newswires

May 02, 2016 12:55 ET (16:55 GMT)

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