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A Thorn in Halliburton's Side Part Two
SPREADING IT AROUND? Nevertheless, KBR remains under fire for charges that it has inflated its Iraq billing. The company has powerful enemies in Congress, including outspoken Representative Henry A. Waxman (D-Calif.), who has attacked Halliburton and its missteps in Iraq as "overcharging the taxpayers." Halliburton denies the allegations and, in fact, on Sept. 7 the Pentagon's Defense Contract Management Agency (DCMA) said KBR's purchasing policies and practices are "effective and efficient."
Yet the Pentagon may still withhold 15% of future payments, amounting to about $60 million a month, on a troop support contract until Halliburton provides details to back about $1.8 billion of work already completed. Lesar says that if that happens, the impact on KBR will be mitigated because it will withhold payments from its subcontractors. The Army is also now considering breaking up its multibillion-dollar logistics contract in Iraq among several players. Halliburton says that it has anticipated that possibility, although it may still bail out altogether if too many bidders vie for the work.
The mess at KBR stands in stark contrast to Halliburton's oil-services business. Thanks to stubbornly high oil and gas prices, it's hitting on all cylinders, making drill bits, testing wells, and providing software to help oil companies improve their drilling odds. Indeed, while the Energy Services Group (ESG) accounted for only 43% of Halliburton's revenue last year, it pitched in all of the company's $720 million operating profit.
"LESS THAN ZERO." Investors believe that KBR's subpar performance is the major reason Halliburton's stock trades at a 20% to 25% discount to other big oil-services outfits such as Schlumberger (SLB ), the industry leader, and Baker Hughes (BHI ). Those companies have price-to-estimated 2005 earnings ratios in the mid-twenties, vs. Halliburton's forward p-e of 19.7. Analyst Robert F. Mackenzie of Friedman, Billings, Ramsey & Co. (FBR ) figures that Halliburton, the No. 2 oil-services player, should be trading at around $40 a share.
He estimates that ESG alone is worth $34.50, and a stand-alone KBR would be worth about $2.5 billion to $3 billion, or $5 to $6 a share. Yet Halliburton trades around $32. To Mackenzie that implies that "KBR is [currently] worth less than zero."
For the time being, Lesar has promoted Andrew R. Lane, a 22-year veteran of Halliburton's oil-services business, to fix KBR's problems. Lane, who is 45, is expected to place bigger bets in the emerging liquefied natural gas (LNG) market -- the business of designing and building plants that liquefy natural gas for shipment and reconvert it at the receiving end. LNG is one of KBR's few bright spots. The unit is the worldwide leader in building the processing facilities, which are in high demand. KBR has built more than half of the existing plants worldwide over the past 30 years.
COSTLY OVERHAUL. KBR also is shifting away from big fixed-cost offshore construction contracts, to contracts where costs can be reimbursed. Such fixed-cost work as the $2.5 billion Barracuda-Caratinga project, which involves converting two supertankers off the coast of Brazil into floating oil production, storage, and offloading vessels, has racked up losses of $762 million over the past three years because of building delays and cost overruns. Says Lesar: "In this business if you have just a few projects with problems it can consume the overall profit margins, and that's what we've seen happen recently."
Analysts say KBR is almost certainly worth more to another engineering outfit than if it was spun off to Halliburton shareholders. "Somebody may buy [KBR] just to get access to its LNG business," says analyst Robert S. Goodof of Loomis Sayles & Co., which owns about 1.5 million Halliburton shares. Prospective buyers could include large engineering competitors such as Fluor (FLR ) and Bechtel Group. Both declined to comment on any potential interest in KBR.
As KBR winds down its work in Iraq, begins using less risky cost-reimbursable contracts for its offshore business, and expands its LNG operations, the troubled unit may crawl back into the black. But the likelihood is growing that by the time KBR gets straightened out, it will no longer be flying the Halliburton flag.
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