Is Halliburton Co.’s troubled-plagued KBR subsidiary a corporate version of “dead man walking”? For the next two years or so, the big engineering and construction unit will undergo a structural makeover to streamline operations, cut costs, and turn losses into profits. But the opinion among industry followers suggests that a separation of KBR from its oilfield services and products parent via a sale, IPO, or spin-off is inevitable. If Halliburton and KBR successfully disengage, it could be a model for cleaving off a subsidiary with financial, operational, and legal baggage that could come back to haunt the parent. KBR’s stock price is deciding factor An important clue to KBR’s future is the high threshold set by Halliburton CEO David Lesar for keeping the beleaguered business, even if it’s turned around. Lesar told analysts when the restructuring was unveiled that keeping or shedding KBR depends on whether Halliburton’s stock price gets to a level that at least matches P/Es of peer companies in the booming oilfield sector. That outcome is considered unlikely as long as KBR remains in the fold, say analysts who see construction and oil services as a dubious strategic fit and note that KBR’s profit margins, at best, will badly trail the double-digit margins in Halliburton’s core business. According to that view, restructuring is largely designed to clean up KBR financially and operationally for eventual disposition. Although, it has been accorded little attention, there is also a thorny legal issue to handle. The exercise apparently also is buying time to ensure that Halliburton doesn’t get bitten by fraudulent conveyance, the legal doctrine under which a new owner can sue for damages if a sold or transferred business is ruined by inherited problems. KBR is potentially a serial time bomb for fraudulent conveyance explosions. The unit has been in bankruptcy since December 2003 while it seeks to settle a boatload of injury claims – 400,000 asbestos and 21,000 silica – totaling about $4.2 billion. While expensive, that problem is at least close to a known quantity. Far murkier are the outcome and cost of KBR’s highly publicized brushes with the U.S. government. The most controversial of the problems to date center on charges that KBR overcharged the U.S. Army for troop support services in Iraq and did not keep the right records to justify the expenses. The allegations are under investigation by several federal agencies, and the Army has considered holding back 15% from future payments. Meanwhile, French and U.S. authorities are looking into allegations of possible bribery by a Nigerian liquefied natural gas joint venture in which KBR holds a 25% stake. Charles F. Rysavy, a Partner at the Newark, N.J.-based law firm of McCarter & English, suggests that the troubles with the government may pose the biggest problems under fraudulent conveyance, given the difficulty in calculating and resolving them. The fundamental issue, he says, is whether the business being sold or spun off “has sufficient assets to pay its liabilities.” “If it has sufficient assets to pay its debts, fraudulent conveyance never comes up.” But he adds that there is a “secondary issue” involving a sold or spun off business that “doesn’t have assets to pay its debts down the road, but it was the intent of everyone involved that it would have sufficient assets and they just were wrong.” “That’s the more common situation,” he says. Slimming down for easier sales Halliburton’s roadmap for KBR appears to incorporate protections against fraudulent conveyance lawsuits whether it gets new owners or becomes a stand-alone entity. For openers, KBR will be slimmed down from five products lines to two divisions – energy and chemicals, which builds oil refineries, natural gas facilities, and other facilities, and government and infrastructure, which provides logistics, maintenance, and other services primarily for government agencies. The new structure could make it easier to sell the parts in separate deals or establish separate companies through spin-offs or IPOs, if willing buyers don’t surface or won’t pay an acceptable price. Indeed, some analysts believe that KBR’s parts are more valuable than the unit as a whole. The company says that the energy and chemicals unit has an industry-leading position in liquefied natural gas (LNG) facilities, a key growth spot in the energy field, while government and infrastructure is a growth situation, despite the troubles in Iraq. KBR, according to projections, should be showing a 1% to 3% EBIT in 2005 while 2006 EBIT should expand to the 3% to 5% range. The unit also is shooting for a double-digit return on common equity. If these goals are reached, KBR would move into the “top quartile” for performance by engineering and construction companies, Halliburton said. Although that would be a marked improvement for a business with three straight years of losses, the numbers also hint as to why KBR’s days as part of the Halliburton fold are numbered. Those margins may be good for construction companies but they pale in comparison to the performance Halliburton traditionally turns in from oil and gas services. That margin was 14% in the second quarter of 2004. Thus, many analysts and Halliburton officials believe that the stock would fare much better as a strong-margin, pure play in oil services and products than if KBR were to be retained. In the strategic arena, construction of energy facilities may have some connection with oilfield operations but analysts say that has become increasingly remote in recent years. The government business has almost no relationship, they add. Disposal at fair value is critical Rysavy says that in addition to ensuring that a divested business is “reasonably capitalized,” a restructuring company has to make sure it’s disposing of assets at fair value so “it’s not moving valuable assets away from problematic assets and leaving the problematic assets holding the bag.” KBR was formed in the late 1990s through a combination of Brown & Root, an engineering and construction firm owned by Halliburton since 1962, and M.W. Kellogg, also a provider of engineering and construction services. Kellogg came with Dresser Industries Inc., which Halliburton acquired in 1998. Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com

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