By Ryan Barnes. Edited By Douglas A. McIntyre
Halliburton Company (HAL) – Price $29.64; Break-up Value $59
Just to acknowledge the pink elephant in the room, yes, the former CEO of the company happens to currently sit behind and to the right of the President during the State of the Union Address. But by our account, the whole affair has hurt shareholders of Halliburton more than it has ever benefited them or the company.
Halliburton has 2 operating segments, the Energy Services Group, and KBR; the latter is the unit responsible for logistics support to U.S. troops, and it has been an extreme drag on the stock. To explain we need look no further than the fact that operating margins at Energy Services run at 26% while those at KBR are a whopping 2.5%. KBR was just recently floated as an IPO, and this should benefit HAL shareholders immensely. The company still isn’t sure if they will spin-off or split-off the remaining 80% of KBR they hold, but whatever the end result, it will happen soon, likely in the first quarter of 2007.
If the P/E at KBR remains higher than at HAL – currently KBR trade at 19x earnings to 13.3x for HAL – the remaining 80% will likely be done in a tax-free exchange for Halliburton shares. There is no logical reason for why HAL doesn’t have a higher current valuation except for the “ugliness” factor, but with KBR gone the image of the company should be vastly improved. However the separation finally occurs, current HAL shareholders will be soon be getting just over $3b in value very soon through either a tax-free dividend or retired shares.
This allows focus to return to the Energy Services Group, which has been performing on a stellar level of late, showing nearly 30% top-line growth in 2006 along with margins gains across the board. The segment is comprised of 4 sub-divisions, running the gamut of oil services from drilling and pumping to seismic software and rig constructs.
Analysts and investors tend to focus on month to month changes in oil prices when evaluating the oil-services companies, but the more important factor is the long-term trend, which has seen the price of crude go from the mid $30’s to the mid $50’s, making drilling and production in the “no-brainer” category for the integrated producers. We don’t see this as a secular trend rather than a cyclical blip, and that demand for drilling will continue. Main competitor SLB trades at a P/E of around 24, and margin numbers are very similar when KBR is taken out of the equation. Halliburton could see solid multiple expansion without any breakup from here, but we’ll outline a breakup into 2 companies that should serve to further highlight what the going multiple should be.
By spinning off the Drilling & Evaluation and Digital & Consulting Solutions segments, the remaining Halliburton would sport 29% revenue growth and 25% operating margins. The spinoff group would have 26% margins and 22% revenue growth. Both would operate worldwide and be involved in many of the same contract. Based on the figures above, the spinoff group should trade for 15-17x operating earnings for a market cap of nearly $17b, while remaining Halliburton should trade for 16-18x op earnings for a market cap of $39.5b. Under this scenario of worthy multiple expansion, the breakup value for Halliburton comes to over $59/share, a very nice premium over current prices and free from petty (and uninformed) “war profiteering” concerns.
Ryan Barnes
Ryan Barnes has over 10 years’ experience in portfolio management and investment research, covering equities, fixed income, and derivative products. Ryan spent the past 5 years working as an institutional trader & manager for high-net worth investors, working with Merrill Lynch, Charles Schwab, Morgan Stanley, and many others. Ryan is currently working as a writer and financial modeling consultant on hedging and capital appreciation strategies, and does not own securities in the companies being covered.
Top Gaining Stocks
Top Losing Stocks