Halliburton: Is Its Discount Warranted?

As energy investors are aware, shares of Halliburton (HAL) have been trading near historically low valuations for much of the recent past. I have largely dismissed the discount as being merely a consequence of having a huge amount of U.S. government business due to the Iraq war.

Once that is over, or as soon as the Bush Administration was out of office, my thinking went that huge no-bid contracts allowing the company to charge the government anything they wanted would vanish, and Halliburton's financial performance would lag. Hence, the stock is discounting this reality in the marketplace.

With the Halliburton spin-off of its KBR, Inc. (KBR) subsidiary, all of the sudden we have the division with much of the Iraq war criticism tied to it trading on its own. After Halliburton disperses its majority stake to shareholders, Halliburton will look a lot more like a leading oil services company, and much less like a company being propped up by the Bush Administration, and more specifically, former CEO Dick Cheney. Interestingly, in 2006 KBR represented 43% of sales for HAL, but only 7% of operating income.

HAL KBR 3-month comparison chart

Comments

[stephen.jacobs]

HAL's Chairman and CEO Dave Lesar, an ex-Arthur Andersen managment consultant, stated in the recent 4th quarter earnings call on 26 January that the planned spin-off of KBR may not occur as proposed. He said instead a possible "split-off", wherein HAL shareholders do not get KBR shares distributed as a tax-free dividend, but will be allowed to trade their HAL shares for KBR shares, is being considered. He gave some reasons but they appear rather lame to me, such as portfolio reallocation tax benefits if you want to concentrate only on one company (to major shareholders' benefit?) and accreting KBR's earnings multiple to add one-time to HAL's EPS. Doesn't this greatly reduce the value of the separation to existing HAL shareholders? Why would they do this?

[Chad Brand]

Another couple of reasons they would do this is to 1) avoid having a lot of selling pressure on KBR once the spin-off occurs, and 2) reducing the number of small investors in KBR.

If HAL shareholders are given a little bit of KBR (relative to their HAL stake), they will either sell the KBR stock when they get it because it is a just a small amount and doesn't really fit with their other regular sized positions, or they just keep it there. The result is either 1) lots of selling of KBR, or thousands of people owning odd-lots of KBR (under 100 shares), which is costly from a shareholder services prospective.

If they can get some investors to swap all of their HAL for KBR, those issues are reduced and HAL's total share count drops without the company needing to do a buyback.

If I owned HAL I would not trade HAL for KBR, but they are hoping some people will.