Oilfield services leader Schlumberger’s (SLB) planned purchase of rival Smith International (SII), in a stock swap worth $11 billion, would allow the combined company to better compete in a changing industry. The need to support natural gas wells being drilled in shale rock is the biggest difference in the business these days, compared to a few short years ago. Exxon Mobil’s (XOM) pending acquisition of XTO Energy highlights the increased customer interest in unconventional resources, including shale formations. Bringing Smith’s drill bit technology in house would allow Schlumberger to better serve its customers’ growing shale-drilling requirements.

The combined company would benefit from highly complementary product lines. Schlumberger competes in about half of the 15 or so assorted oilfield services markets that generate $1 billion or more in annual revenue, with its strength mainly in the largest lines. In addition to drill bits, Smith International brings to the table expertise in drilling fluids, specialty chemicals, and a few other lines where Schlumberger has little or no presence. A Schlumberger-Smith deal would offer customers full coverage of the industry’s most often used products and services. Schlumberger’s broad geographic footprint would also enable it to extend Smith’s offerings worldwide.

Putting the two companies’ product lines together could facilitate the next generation of drilling technology. Schlumberger Chairman and CEO Andrew Gould has indicated that extracting natural gas from shale has been done partly with ``brute force’’ early on, in the absence of the detailed knowledge that comes with years of experience in particular types of formations. Mr. Gould strongly feels that the next breakthrough will arise out of an integrated drilling system that makes best use of all of the component parts. Having Smith’s know-how on board would greatly help in that regard, and give the proposed combination a leg up on competitors Halliburton (HAL) and Baker Hughes (BHI). Baker Hughes, it should be noted, is beefing up its shale-drilling capabilities by acquiring BJ Services (BJS).

Schlumberger is paying a steep 37.5% premium for Smith International stock, based on closing prices just prior to the deal’s announcement and its offer of 0.6966 of an SLB share for each SII share. Negotiations had been ongoing for some time, but the two sides had not been able to agree on a price. Exxon Mobil’s bid to buy shale-drilling trailblazer XTO energy may have helped motivate Schlumberger to finalize a deal for Smith. After initial expenses, the Schlumberger-Smith deal would result in sizable estimated pretax cost savings of $160 million in 2011 and $320 million the following year. The merger would likely add to earnings in 2012.  The deal’s cost caused Schlumberger stock to falter after the announcement, but it has since recovered.     

If approved by regulators and Smith’s shareholders, the transaction could close by the end of the year. Antitrust regulators will probably take a close look at the proposed combination, and divestitures in some areas that overlap are a distinct possibility. But the largely complementary nature of the move may ultimately help it pass muster, and usher in a new era in the oilfield services industry .