Special Situation Investing

Sunday, February 18, 2007

Halliburton (HAL) - Spinoff of KBR Unit Continued

I did a bit more digging on the specifics of the KBR spinoff from HAL. The initial IPO of KBR stock represent approx 19% of outstanding stock. The remaining portion will be distributed by Halliburton to existing shareholders, hopefully via a spinoff. KBR currently has a market cap of $3.74 B which includes the 81% ownership by HAL. As such, ~$3 B of HAL's market cap is attributable to it's KBR stock. Excluding that $3 B from HAL's market cap of $30 B gives a rough value of $27 B for HAL post-KBR.

So you could say that the market is valuing HAL's energy services group at $27 B. Energy services provided $3.4 B operating income in 2006 and $2.3 B in 2005. This was generated from $13B revenue in 2006 vs $10B in 2005. Interest expense was nominal and largely counterbalanced by interest income. Taxes take roughly 1/3 of profits. This leaves us with $2.3 B or so net income from the energy group against the $27B market cap and provides for a P/E of less than 12. The unit is likely to grow at least in the short-term as demand for it's services continues. The oil majors, especially Exxon (XOM), have been holding back on oil exploration until the last couple years after being burnt by previous oil rallies. This is starting to change, as confidence that oil will remain high historically builds and as the majors struggle to maintain existing production. The company also has decent geographic diversity with ~55% of revenue coming from outside North America.

What you need to keep in mind, however, is that in the long-run if the price of oil were to fall the majors eventually would scale back their exploration and development projects. Have a look at it's five year chart to see how much it has surged with the price of oil.

Theoretically, KBR should be the asset of choice in this transaction. It is significantly smaller than HAL ($3.7 B against $27 B), it is hated, it's dependance on government contracts make revenue and earnings unpredictable, and it is in a different sector than HAL. By all rights, this stock should get pounded after the spinoff occurs. You would think that most HAL owners would just love to get rid of the stock and associated bad memories. We will see if that happens. Personally, I would only be a buyer of KBR if it got absolutely nailed as at present I am not particularly interested in this type of business, I don't see much competitive advantage and god only know what it's future revenue will be like. In other words, it legitimately might be a bad buy and needs a greater discount for me to purchase. Consider that it IPO'd at $17 and currently trades for $22.88 so it is already considerably higher than initially valued by it's owners.

HAL is not the only cheap oil services company either, Baker Hughes (BHI) goes for about 13x forward estimates and Schlumberger (SLB) for about 13.5 x forward earnings. So yes it is cheaper than it's competitors but then again it has lower margins than them as well.

On the flip side, I'll just throw in that George Soros bought some 1.9 million shares in HAL during the past quarter.

What it comes down to is your perception of where oil prices are headed. They don't need to surge upwards for HAL to be a good buy, even if the market could maintain present prices for awhile you could see upward pressure on the stock. However, I already have energy exposure and quite frankly I think Schlumberger is a superior company to HAL. I will keep an eye on the price of KBR and may take advantage of any selloff's that occur post spinoff.

If you are still interested in HAL, check out the fourth quarter results here.


  • What do you know about TMY?

    By Anonymous Anonymous, at 11:07 AM  

  • Sorry, never heard about it before. Is it a special situation?

    By Blogger spinoff, at 4:06 PM  

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