Lufkin Industries, Inc. (NASDAQ:LUFK)’s products are integral to the operations of traditional extraction companies. Going forward, short-term investors may be able to earn a premium on the actual completion of its deal. Over a longer period of time, investors in General Electric Company (NYSE:GE) and other oil-industry players may also earn significant returns.
The lesser known Lufkin Industries is an industrial company that produces oil pumps and power transmission equipment. In addition to the artificial lift equipment that can be found in 19 of every 20 producing oil wells around the world, the company also manufactures products such as gearboxes, and engages in a number of support services. With a profit margin of just under 7 percent and a return on equity metric of 12.4 percent, Lufkin’s balance sheet contains nothing out of the ordinary. Although the company’s debt ratio is slightly better than General Electric Company (NYSE:GE)’s, it did recently post about $505 million in negative free cash flow.
Other Oil Pump Players
While Lufkin is often treated as a de facto monopoly in its primary area of operation, the company does have one significant competitor: Geneva-based Weatherford International Ltd (NYSE:WFT). Like Lufkin, Weatherford makes a variety of artificial lift systems and hydraulic oilfield services equipment. Unlike Lufkin, it has not been profitable of late. In 2012 Weatherford lost about $778 million on over $15 billion gross revenues. While some of this loss could be attributed to its oilfield operations, it bears noting that Lufkin appears to be in a better strategic position. Weatherford has a profit margin of negative 5 percent and a diluted loss per share of $1.02. To make matters worse, the company posted negative free cash flow to the tune of $610 million and has about $27 in debt for every $1 in cash on hand.
Immediate analyses of this deal’s impact have focused on its potential to spawn layoffs and plant closings in Lufkin’s East Texas trade area, but investors should be more concerned about General Electric Company (NYSE:GE)’s potential to make a big splash in the North American shale industry. Since Lufkin’s artificial lift equipment is essential to the process of extracting oil and gas from shale formations, GE’s added heft may well turn these products into the accepted industry standard. This could further erode Weatherford International Ltd (NYSE:WFT)’s competitive position.
Ways to Profit
Under the terms of this deal, Lufkin shareholders will receive cash payments of $88.50 per share. Relative to the company’s current share price of about $88, this represents a premium of slightly less than 1 percent. The deal looks likely to close during the second half of 2013.
Although this deal currently offers a relatively small premium for Lufkin investors, those who believe that brewing shareholder discontent with the current offer price will prompt General Electric Company (NYSE:GE) to make a higher offer would do well to buy into the company at these levels. Although this deal is still in its preliminary stages, there is at least one open legal investigation that concerns it directly. Since such investigations are quite common, this is not a particular cause for concern, though it does bear watching. In particular, the investigation takes issue with the restriction that the deal places on Lufkin’s ability to solicit other bids. It also mentions an onerous breakup fee and implies that the $88.50-per-share offer price significantly undervalues Lufkin. Alternatively, those who believe that Lufkin represents a good long-term investment may wish to buy into the company on the expectation that it will boost GE’s earnings in the coming years.
In sum, this deal offers an impressive opportunity for investors who wish to grab a piece of the booming shale market. Depending upon the needs of each individual investor, it can be played as a short-term arbitrage opportunity or a long-term value play. Of course, investors are reminded to conduct their own due diligence before making a purchase.
The article Massive Company Moving Into Shale Gas originally appeared on Fool.com and is written by Mike Thiessen.
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