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GE's Pricey Shale Deal May Not Be Its Last: Pros

Monday, 8 Apr 2013 | 3:43 PM ET
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General Electric's deal to acquire Lufkin Industrials makes strategic sense, but it comes at a high price, analysts say.

In a further effort to beef up its oil and gas business, GE shelled out $3.4 billion for Lufkin, a company that provides artificial lift technologies to the industry and manufactures industrial gears. Artificial lift equipment helps extract crude oil and other fluids from wells.

(Read More: GE to Buy Oil & Gas Giant Lufkin for $3.38 Billion)

Steven Winoker, an analyst at Sanford Bernstein, called out Lufkin as a potential acquisition for GE last fall. "This is a good move from a strategic standpoint," he said Monday. "If you look at the services side of the business, combining GE's new artificial lift business with Lufkin's traditional lift business makes a lot of sense."

Other analysts agreed. Morningstar's Daniel Holland said that GE continues to build up its oil and gas platform as it positions itself to provide exploration and production clients with a range of solutions, so "GE is going to win no matter what" type of energy production takes off.

But Winoker and Holland say GE may have paid too much at 13.5 times 2013 estimated earnings before interest, taxes, depreciation and amortization.

"The price paid is a bet that the surge in oil drilling in North America will continue and the shale oil development overseas will take off," Winoker said.

GE's announcement of the deal said the global artificial lift sector is approaching $13 billion in 2013, according to Spears & Associates, as development of unconventional shale plays and liquid-rich resource plays surges ahead.

Winoker took a dimmer view, expecting growth in North American shale but at a much reduced pace from the past three years. This slowdown is because the premier shale plays are maturing and the new discoveries are much less attractive, he said.

Chairs: GE Buys Lufkin Industries
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Holland, meanwhile, said that while it seems GE paid a hefty premium for Lufkin, the price may not be as high as it first appears if GE is able to successfully apply Lufkin's technology in other areas of its industrial businesses.

Nonetheless, Winoker said that GE tends to overpay for acquisitions. "GE needs to make acquisitions in core and adjacent businesses, but at reasonable prices," he said.

He maintains a "market perform" rating on the stock with a $25 price target, which implies about 6 percent upside. He said GE has a tendency to overpay, and that's a challenge to value creation.

GE's Transformation
Monday, 8 Apr 2013 | 3:14 PM ET
General Electric is paying $3.3 billion for Lufkin Industries to expand its oil and gas equipment business, reports CNBC's Mary Thompson. What this means for the company, with Daniel Holland, Morningstar, and Christopher Glynn, Oppenheimer & Co.

More Deals Looming?

This may not be the last deal GE pursues. At GE's December analyst meeting, CEO Jeffrey Immelt said the company would focus on bolt-on acquisitions in the $1 billion to $3 billion range.

According to a research note from Citi analyst Deane Dray, "GE should have roughly $41 billion to $44 billion of firepower for investor-friendly capital allocation in 2013 from operating cash flow, dividends from GE Capital, and the $13.5 billion in after-tax proceeds from the NBCU deal." He was referring to the $16.7 billion deal in which GE sold its 49 percent stake in NBC Universal to Comcast. (NBCU is the parent company of CNBC and CNBC.com)

With GE expecting to use $10 billion for buybacks in 2013 and $8 billion for the dividend, that "still leaves plenty of room for opportunistic $1 billion to $3 billion bolt-on deals such as Lufkin," the Citi analyst wrote.

Oppenheimer analyst Christopher Glynn told CNBC the Lufkin deal was a sea change in GE's capital allocation strategy over the long-term as the company is now focused on targeted acquisitions on the industrial side instead of the riskier financial side of the business. "They're pulling the portfolio gradually away from the financial and retrenching that very methodically," Glynn said.

Winoker expects more deals in energy and aviation as well as in health care as GE continues to pivot away from GE Capital to its industrial businesses. Holland continues to expect GE to fill any key technological holes in their oil and gas product offering.

The Morningstar and Citi analysts are more bullish on GE than Bernstein's Winoker. Citi, which rates the stock a "buy," notes that at 13.1 times 2013 earnings GE trades at a 14 percent discount to peers. Their $28 price target assumes the shares trade in line with peers and implies 26 percent upside including the 3.4 percent dividend yield.

Holland has a price target of $27 on the stock, saying "Long-term, this company is levered to some very good fundamental growth drivers," pointing to aviation, gas power generation and medical equipment.

Holland said the stock is not "jumping up and down cheap," but it remains undervalued.

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Disclosures:

Citigroup Global Markets has received compensation for investment banking services from GE within the past 12 months and intends to receive or seek compensation for investment banking services within the next three months.

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