By Ted Mann

Jeff Immelt, the chairman and chief executive of General Electric Co., said the purchase of Baker Hughes Inc. will help the industrial giant bulk up and weather a prolonged slump in the energy industry.

But the complex transaction, which will carve out GE's oil-and-gas business into a separate publicly traded company, also raises questions about how far Mr. Immelt will go in slimming down its once-sprawling corporate portfolio. GE's oil-and-gas business accounted for about 14% of GE's revenue last year.

In an interview Monday, Mr. Immelt dismissed the idea that he was shrinking GE's industrial reach. "I look at this as a strengthening, not a separation," said Mr. Immelt, who will serve as chairman of the newly formed company. "I think this is a unique transaction, but not one that necessarily needs to be applied elsewhere."

Mr. Immelt, who has steered GE for 15 years, has spent the past few years revamping the 124-year-old conglomerate. After the financial crisis, he sold off much of GE's massive finance arm, which once had more than $600 billion in assets and generated as much as half of GE's annual profit. He also spent more than $14 billion since 2007 on acquisitions building up its energy business and last year paid $10 billion to buy Alstom SA's power plant business.

Separating GE's oil-and-gas business would leave behind a smaller industrial player with around $100 billion in annual revenue that is largely focused on four businesses: jet engines, power turbines, medical scanners and locomotives. Alongside the transaction, GE said it would sell its GE Water business, which makes water treatment and processing systems.

General Electric will own two-thirds of the newly formed Baker Hughes, control its leadership and include its results in GE's financial reports. GE Oil & Gas chief Lorenzo Simonelli will serve as CEO of the combined company, which will have about 70,000 workers and more than $30 billion in annual revenue. GE will select five of the nine directors.

The Baker Hughes acquisition was a chance to "complete the business strategically," Mr. Immelt told investors on a conference call Monday. GE executives said they expected a slow recovery in energy prices, with crude prices expected to be $45 to $60 a barrel through 2019.

GE's strategy in the oil business wasn't about timing price spikes in crude, Mr. Immelt added, but about developing advanced equipment for an industry that was "going to become more technically sophisticated as time went on."

"That's what we've been betting on all along," Mr. Immelt said. "So I think when this opportunity came up, it just made all kinds of sense for investors of both companies and our customers to grab it."

Mr. Immelt's move comes after two years of struggle in the oil unit, which saw sales and profits plummet after the price of crude oil collapsed. GE is in the midst of cutting more than $1 billion in costs out of its oil business, and acknowledged to investors on its third-quarter earnings call that it would eventually run out of room for more cost savings.

Combining with Baker Hughes will give executives a large new target for cost-cutting, and GE said Monday that it has already targeted $1.2 billion in cost-cuts through 2020 at the combined company.

The new company will be "far more resilient and cycle resistant," Baker Hughes CEO Martin Craighead said Mondayon the conference call for investors.

GE shareholders, including Trian Fund Management LP, welcomed the transaction. Shares of GE rose 11 cents, or 0.4% in afternoon trading, while Baker Hughes slipped 5.8% to $55.70.

"Trian believes the combination has strong industrial logic," said a spokeswoman for Trian, which took a stake in GE last year. "Trian also applauds GE for structuring an attractive transaction that should crystallize a superior valuation multiple for GE's Oil and Gas assets."

As part of the transaction, GE will pay $7.4 billion to fund a special dividend for Baker Hughes shareholders. Those funds will come from roughly $20 billion of leverage GE plans to add to its balance sheet, and which some investors have hoped to see devoted to buying back the company's shares.

GE and Baker Hughes executives said the structure of the transaction would provide GE and the merged company with $800 million to $1 billion intax benefits over time, largely derived from existing benefits at Baker Hughes that it was unable to take advantage of. The merged company will have headquarters in London and Houston.

The merger will provide distance for GE from the sluggish recovery of the oil business, which, despite glimmers of hope in recent quarters, has weighed heavily on the company's returns. With its controlling stake in the new Baker Hughes, GE will be positioned to reap the rewards if the oil and gas business rebounds, the company said.

Still, it wasn't clear how long GE will hold on to its interest in the unit, one of the largest acquisition projects of Mr. Immelt's tenure -- and the company raised the possibility that it could spin off the investment in the future. "The structure as you see it today does not preclude doing a spin or split in the future on a tax-free basis," GE finance chief Jeffrey Bornstein said on Monday's investor call.

The deal is "positive strategically" for GE shareholders, said Steven Winoker, an analyst at Sanford Bernstein & Co., in a note to investors. "This Baker deal is also an attractive structure for GE: without requiring a full cash outlay for Baker Hughes, the 'New' Baker provides GE shareholders with additional upside to an oil price recovery," he wrote.

Bill Herbert, an analyst at Simmons, said the transaction will put new pressure on Baker Hughes rivals Schlumberger Ltd. and Halliburton Co. The combined GE-Baker Hughes will be "at minimum a considerable competitive nuisance with regard to bidding on big projects," he said.

Mr. Herbert called the deal a lifeline to Baker Hughes, but he said the new partnership with GE may worry Baker Hughes shareholders because it leaves the company more leveraged to deep water and international projects, which aren't as flexible as the U.S. onshore business.

Mr. Simonelli, who will run the combined company, said the merged company would have a more diverse portfolio and better ability to weather downturns in niches of the oil industry, like subsea production. "We're actually creating a stronger business," Mr. Simonelli said.

GE executives said they are confident the combination will pass muster with regulators, who objected to Halliburton's attempt to acquire Baker Hughes on anticompetitive grounds. GE is largely a seller of oil and gas equipment, while Baker Hughes specializes in oil-field services.

--Erin Ailworth contributed to this article.

Write to Ted Mann at ted.mann@wsj.com

(END) Dow Jones Newswires

October 31, 2016 13:43 ET (17:43 GMT)

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