It's been a tough couple of months for Texas.

First, Houston's economy gets shelled due to the collapse of Enron (NYSE: ENE), replete with layoffs by the thousands, suddenly unneeded "in-process" real estate, and a loss of paper wealth among its citizens in the billions of dollars. Then Dallas-based oil services giant Halliburton (NYSE: HAL) suffered a 40% drop in share price after it disclosed that its asbestos litigation liability may be "materially more than previously expected." That 40% represented about $5 billion in market value.

Plus, the Houston Astros flailed in the baseball playoffs, the Dallas Cowboys can't beat anyone whose name doesn't rhyme with "Mashington Wedskins," and the University of Texas biffed a chance to play for the national championship in college football. When the fortunes in oil and football are going the wrong way in Texas, you know a lot of people there are not at all pleased.

Halliburton's woes are not, however, related to either oil or football. They are from litigation from asbestos, a flame retardant material that, as it turns out, causes amongst other things, mesothlioma, a deadly form of cancer. Asbestos use peaked in the U.S. in the 1970s, though some experts say deaths from asbestos-related illnesses are not expected to crest until 2010. Therein lies the beginning of the problem for Halliburton and other companies with asbestos litigation risk: With diseases that can take more than 20 years to develop after exposure, no one has any idea how much the eventual claims will be, or when they will stop.

Here's where it gets strange. As it turns out, Halliburton, which has in the last three months lost three court verdicts with liabilities at about $125 million, isn't and has never been involved in asbestos. Instead, Halliburton merged with a company, Dresser Industries, in 1998, more than a dozen years after Dresser had been involved with asbestos. However, Halliburton's merger with Dresser came with the assurance that Dresser's liability for claims was insured. But since the insurer has no means to cover claims, the responsibility to pay goes right back to Halliburton, which has money and assets to spare.

That's right. Halliburton is on the hook for potential asbestos litigation for being in the wrong place, and having a whole lot of money. It doesn't really seem fair, but then again, neither is it fair to the victims of nasty diseases brought upon by exposure to asbestos fibers. Aristotle called the law "reason free from passion," so really whether or not treatment of Halliburton is deemed fair by the general public matters not at all.

Why not sue the companies who produced the asbestos in the first place, you say? Well, for one thing, more than 25 companies, including USG (NYSE: USG), W.R. Grace, (NYSE: GRA), and Owens Corning (NYSE: OWC) have already filed for bankruptcy due to massive asbestos-related liabilities.

Other companies have some unknown asbestos liabilities as well. Sealed Air (NYSE: SEE) held a conference call to comfort investors that its asbestos liability has not changed and were inconsequential and that all cases against the company "are inactive pending the disposition of the Grace bankruptcy." Sealed Air, like Halliburton, has never had any asbestos operations. In Sealed Air's case, it purchased a division of W. R. Grace. When Grace filed for Chapter 11, two committees representing asbestos-related claimants filed motions with courts to pursue Sealed Air as being successively liable. The company believes that the chances of this happening are slim, but admits that quantification of claims against it should its defense fail is impossible.

There are a couple of lessons here. First of which is that no one is safe from the plaintiff's bar, but that is not so much an investment issue as it is a reality of living in these United States. The second issue is that uncertainty can murder stocks. Do you think that Halliburton's 42% drop had to do with the potential payout of $30 million? The company might have $30 million in its petty cash drawer. Halliburton has had done to it what Philip Morris (NYSE: MO) was feeling in 1999 (and may still be today): when investors cannot quantify a known and realized threat, they will assume the worst.

Do I really think that Sealed Air is going to be held liable? I am not a lawyer, nor am I familiar with the case. I do deeply admire the company Sealed Air, but frankly would have a really hard time building in a risk model that takes the ultimate magnitude of potential asbestos liabilities into account.

To demonstrate, let's take Sealed Air's average Free Cash Flow over the last four years, which comes to an annuity-like $311 million.

In thousands
                          (annualized)2001     2000      1999     1998

Net cash from operating activities  492,720   329,413   430,354  411,646 

Capex for property and equipment   (146,317) (114,197)  (75,080) (82,408)

Free Cash Flow                      346,403   215,216   355,274   329,938

Let's assign no growth in free cash flow and an 11% discount, both of which are extremely conservative for a company with such demonstrably stable economics. Using these numbers I calculate that the intrinsic value for Sealed Air is roughly $3.13 billion, which is about 8% below where the company is priced at this moment. Recognize that I priced in no growth whatsoever, where Sealed Air's actual historic growth rate has been nearly 15% over the last five years. With this in mind, I don't have a problem calling Sealed Air inexpensive, on the face of its operations.

But how do you price in a risk that, while remote, could decimate the company? Seeing as several insurance companies have failed due to inadequate capital to cover asbestos claims thus far, it's pretty safe to say that individual investors are ill prepared to make an informed guess. Thus, when Halliburton got rocked due to its rising exposure to claims, it's pretty natural for investors to look who else might be on the list and to run like hell.

Now, Sealed Air's management may well be correct. I hope they are and wish them the best, because they run a dynamite company. If they are correct and have no successor liability to Grace, this will turn out to have been a stock that was devilishly underpriced. But that's just the thing, isn't it? It's pretty rare for a stock to be underpriced when there are no apparent problems -- the market is simply more efficient than that. This asbestos liability beast has destroyed nearly every company that it has attacked. Investors in any company with potential exposure to it must understand that the consequences could be severe.

Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards

Bill Mann knows the pain of successor liability. He gets hit with it whenever one of his friends makes his wife mad. He owns none of the stocks mentioned in this article.