Halliburton and KBR Call It Quits

If there were ever a divorce made in heaven, Halliburton (NYSE:HAL) might consider its separation from KBR as divine. Shareholders who would prefer to hold a pure play in the energy services sector may also rejoice in the new, leaner Halliburton, currently selling at a discount to its competitors

The trial separation of less than 20% of KBR (NYSE:KBR) from Halliburton, as an IPO of 32.02 million shares, was a resounding success. The offering debuted at $17 per share, but by close of day, it had increased to $20.75. The rest will be spun off in the spring of 2007 to HAL shareholders

As dry as SEC documents can be, you can read pure emotion in Halliburton's desire to be rid of the troublesome KBR.

"We intend to completely separate KBR, Inc. from Halliburton as expeditiously as possible through a tax-free dividend distribution of KBR, Inc. stock to Halliburton stockholders.... We do not intend to delay the complete separation of KBR to wait on favorable conditions for an IPO of KBR, Inc."

Ah, the flames of love reduced to cold embers.

Irreconcilable differences
Halliburton acquired Brown & Root in 1962, and Kellogg became part of the marriage (now KBR) in 1998, through its merger with Dresser Industries and Halliburton's acquisition of Dresser. The 1998 acquisition of Dresser brought a lot of baggage to the union, including asbestos litigation and alleged bribery of Nigerian officials. The asbestos settlement has cost the company billions of dollars over the past few years, and the ongoing investigations into the Nigerian malfeasance could result in fines, civil penalties, disgorgement, and injunctive relief. At $500,000 per civil violation and $2 million per criminal violation, is it any wonder Halliburton is pushing for a quickie divorce?

KBR has also had disputes with the U.S. government for alleged improper documentation of subcontractor costs, investigations into kickbacks in Kuwait, and overcharges for work in the Balkans. These issues leave with KBR, along with the costs of the ongoing legal expense, and perhaps some of the negative press that has dogged the company in recent years.

Attractive, single energy-services company seeking...
When the spinoff is complete in spring 2007, it will leave an energy services company with a strict focus on business. The newly single Halliburton will cater to the needs of oil and gas producers with drill bits, fluids, cementing, and software that evaluates seismic data in exploration.

Even though KBR provided nearly 50% of Halliburton's revenue, as you can see below, it added little to the bottom line, with meager 4% operating margins in 2005, and net margins of 2%. Those numbers lagged significantly behind Halliburton's, dragging the combined results down.

Without KBR, it is likely that Halliburton will close in on the 20%-plus operating margins more typical for the sector.

The competition
Operating margins will improve when Halliburton sheds the less profitable KBR. Since KBR makes up nearly 50% of revenue but only 10% of operating income, the bottom line is not going to suffer much after the spinoff. Looking at the table below, this potential for improvement has not earned it much respect in the market; Halliburton trades at a discount to its peers by several metrics.

Without the ol' ball and chain, the newly single Halliburton may find love in the market yet.

Make a date with further Foolishness:

• A Tale of Two Halliburtons
• Schlumberger: Crude Resistance
• An Energy Services Starter Kit

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Fool contributor Jean Graham owns shares of Halliburton and BJ Services. The Fool has a disclosure policy.