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What's Lighting Halliburton's Fire

By Brian Hindo Democrats howled when oil-field services behemoth Halliburton scored a no-bid contract to do work in postwar Iraq. With Vice-President Dick Cheney among its CEO alumni and former Secretary of State Lawrence Eagleburger on its board, it's almost impossible for the Dallas company to avoid complaints of political favoritism. Investors have paid attention to Halliburton (HAL), too -- for a different reason: The stock has risen 25% this year, closing on May 20 at $23.09 -- near its recent 52-week high. That compares with a 9% gain over the same period for rival Schlumberger (SLB) and a 4% gain in the S&P 500-stock index.

The stock isn't going gangbusters because of Iraq deals, shady or otherwise. Indeed, the $75 million in revenue that Halliburton has collected so far by putting out oil fires and repairing refineries in Saddam Hussein's former turf will add insignificantly to its profits -- perhaps a penny a share this year. Even if the contract eventually reaches $600 million, as projected by the U.S. Army Corps of Engineers, it'll account for less than 4% of Halliburton's annual revenue.

What has really made the stock hum, analysts say, is the impending settlement of longstanding and costly asbestos litigation, much of which Halliburton inherited when it acquired Dresser Industries in 1998. Last December, Halliburton agreed with plaintiffs to set up a $4.2 billion trust for asbestos victims, $2.775 billion of it in cash and the rest in stock and notes. As part of that deal -- which Halliburton says should be finalized by mid-July -- subsidiaries Kellogg, Brown, & Root (the company's engineering and construction unit), and industrial equipment maker DII (formerly Dresser) will file for Chapter 11 bankruptcy protection, thus shielding them from future damages.

ESCAPE HATCH? Halliburton could hit a delay or two along the way. For instance, its lawyers have to scrutinize some 320,000 claims before signing off on the deal. Finding false or inaccurate claims could give them ammo for trying to reduce the $4.2 billion pool. Also, while vetting the claims, Halliburton can build its case for recouping as large a share of damages as possible from insurers -- a kitty that could total $2.3 billion to $3 billion. Says Dallas attorney Donald E. Godwin, who's supervising Halliburton's effort: "We're working seven days a week. We're doing all we can to get there."

Some observers aren't so sure. Senator Orrin Hatch (R-Utah) is set to introduce asbestos legislation on May 22, and Halliburton might be foolish to close its deal until it sees what Hatch can deliver. His proposal calls for the creation of a universal asbestos trust fund of $108 billion, to be financed primarily by 20-odd insurers and companies facing asbestos claims, that would cap future liabilty for these companies. The bill's prospects are unclear.

However, attorney Peter Kraus, who represents asbestos victims, thinks Halliburton will "jump on board" the Hatch plan if it promises a smaller settlement than the pending deal. Given the time it will take for the legislation to either pass or be shot down, Kraus pegs the chances of a mid-July resolution of suits at "less than 50%."

UPBEAT OUTLOOK, IF... Thus, on May 12, Morgan Stanley downgraded Halliburton's stock to equal-weight, or neutral, citing risks of a delay in the settlement. In essence, Morgan analysts Ole Storer and James Lewis decided that they dislike uncertainty more than the possibility of better deal for Halliburton. They also pointed to the 42% run-up in its stock over the past six months as evidence that the market has already priced in an asbestos settlement.

Analyst Kurt Hallead at RBC Capital Markets in Austin agrees: "The market is telling us that a substantial amount of the asbestos risk is more or less behind the company now." (Hallead has no investment banking ties to Halliburton or stake in the stock. Morgan Stanley does banking business with Halliburton.)

Analyst C.K. Poe Fratt at A.G. Edwards in St. Louis maintains his hold rating -- pending the resolution of the asbestos claims. But he says the long-term outlook is upbeat, provided oil and gas prices stay strong -- and that overall capital spending increases. That's no sure bet. (Fratt doesn't own Halliburton shares). "Before asbestos, we were looking at earnings per share of $1.11 for this year and $1.61 for next year," Fratt says. "When you factor in the settlement charges, we go from $1.61 down to $1.12." Accounting for the financial impact of the asbestos settlement, he expects revenues in 2003 to rise about 3%, to $12.9 billion, and in 2004 to rise an additional 6%, to $13.8 billion.

"GREAT NEWS STORY." Though oil and gas prices have cooled recently, Fratt thinks they remain high enough to spur more exploration and drilling. That's good news for Halliburton's energy-services division -- which provides nearly two-thirds of the company's revenues and more than 80% of its operating income. Kellogg, Brown, & Root, by contrast, continues to be hampered by a Brazilian construction project that saddled it with a $34 million aftertax charge in the first quarter -- though Fratt and other analysts see a turnaround there, thanks to new KBR contracts overseas.

Another positive sign on the horizon -- a distant one, to hear most analysts tell it -- is Iraq. KBR enjoyed a 39% uptick in government contracts in the first quarter, mostly because of the U.S. invasion. Even though revenues from the oil-rich nation have been small so far, Iraq looms as a potential windfall, since Halliburton generates more than 60% of its revenues overseas. Deutsche Bank analyst Michael Urban pegs the potential Iraqi oil-field services market at $3 billion. That's just to get the country's oil machine back up to speed and doesn't include new development or drilling projects, which could add billions more.

Most other analysts aren't willing to estimate Halliburton's revenues from Iraq, citing, among other variables, the lack of a stable government. "You're not going to see any substantial oil-field services business for at least another year to 18 months," Hallead says. "It's a great news story," adds John Kartsonas, oil-field services analyst at Standard & Poor's, "but right now it has nothing to do with the earning power of the company."

Halliburton's oft-deferred farewell to asbestos and anticipated hello to Iraq could still be a boon. Indeed, Morgan Stanley's Storer and Lewis, despite their downgrade, have bumped up their target price on Halliburton over the next 18 months to $35 from $25 -- reflecting its potential post-settlement earnings power. Given the stock's recent rise, however, investors may want to wait to see if the dust finally settles on its asbestos problems. Hindo covers financial markets for BusinessWeek Online in New York

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