Baker Hughes Is Being Held Hostage

Baker Hughes is waiting on the pending merger with Halliburton, and until there is clarity here, the company's hands are tied in terms of what it can do.

Q1 earnings are out, and they are pretty dire.

I discuss the key metrics and don't like what I see.

It's all about oil prices and survival tactics now.

Baker Hughes (NYSE:BHI) is a name that I initiated coverage on last Fall. And as you know, there is real danger of Halliburton's (NYSE:HAL)acquisition of the company falling through. Therefore, we should still be following, and have the ability to invest and trade, Baker Hughes. There is no guarantee the deal will go through, and each day it looks less likely. Maybe both parties will agree to extend the deadline again. Perhaps Baker Hughes will just collect the dealbreaker fee. We shall see. Regardless of what happens, you know that I much prefer both companies' rival, Schlumberger (NYSE:SLB). Although the companies are very similar, they have important differences, and also differences in how they are managing the so-called oil price crisis. The pain is real. Baker Hughes' stock has been crushed along with Schlumberger's and Halliburton's in the last two years. All that said, independent of an acquisition by Halliburton, will the company survive?

I always say it doesn't matter where a stock has been, it matters where it is going. To judge that, you have to know where the company is going. So let's talk about Baker Hughes' recent performance. With oil & gas prices so low of late, it has certainly impacted the company and its earnings. Simply put, the higher the price of oil, the better. Common sense, right? That's true for all of the oil & gas names. But because oil & gas has dropped so much, expectations for the company have declined as well. Well, even with pitiful expectations, Baker Hughes missed its numbers badly.

So what kind of numbers are we talking about? Baker Hughes missed on the top and bottom lines. The company saw revenue of $2.7 billion for the quarter, down a whopping 21% compared to Q4 2015. Compared to Q1 2015, revenue declined $1.9 billion, or 42%. It also missed estimates by $150 million. On an unadjusted basis, the company lost $981 million, or $2.22 per share. On an adjusted basis, it lost heavily and missed estimates badly. Adjusted net loss was $701 million, or $1.58 per share, and this whiffed estimates by $1.24.

So just how did Baker Hughes get here and miss earnings like this? Well, it is because there was another massive decline in activity in the sector, exceeding even the most pessimistic expectations for the sector. This hit revenues, but expenses were higher than expected despite the work of the company to manage them.

For the quarter, capital expenditures were $86 million, declining sequentially and year over year. The reduction in capital expenditures is attributable to lower activity levels. Depreciation and amortization expense for the quarter was $354 million, down from last year after taking impairments. Corporate costs were $32 million. There were also a number of after-tax charges, and merger & acquisition fees accounting for another $280 million. Of course, operating costs continue to do the most damage and were at $2.65 billion. This is why oil prices need to rise for the company to survive. It needs revenue. Martin Craighead, chairman and CEO of Baker Hughes, really put the issues in perspective, stating the following:

"As a result of this steep decrease in customer spending, our revenue for the first quarter was down 21% sequentially. Compared to the prior year, revenue declined 42%, driven by lower activity as evident by the 41% global rig count drop, reduced pricing across most markets, and the strategic decision to continue limiting our exposure to unprofitable onshore pressure pumping business in North America. Despite the severity of these headwinds, decremental operating margins sequentially and year-over-year were contained to 28% and 13%, respectively. Although we have taken significant actions to manage our cost structure during the downturn, we are retaining costs in our operating profit margins in compliance with the merger agreement. Additionally, the unique circumstances in which we are operating limit our ability to consider and action a broader range of measures required to align the company with the current and near-term market conditions."

As you can see from the comments, the company's hands are tied. It's almost being held hostage by the merger agreement that is being worked on, as it can't follow some avenues it might ordinarily follow to survive. As such, revenues have been crushed, especially in North America. Managing cash has been a central theme for the company. Free cash flow for the quarter was in the red at -$103 million. Excluding restructuring payments of $296 million, free cash flow would have been $193 million for the quarter, slightly better than I thought considering the environment Baker Hughes is operating in. Still, no matter what the company does, oil prices dictate the action. The overall global economic outlook continues to be mixed. The pending merger continues to hamper the name from doing much of anything. Some analysts think the merger falling through is bullish. Others think it is bearish. For me, there is too much uncertainty. Wait it out. Don't get involved here.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles that are time sensitive. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."