Halliburton (HAL)

Houston, Texas-based Halliburton Company (HAL) is one of the largest oilfield service providers in the world, offering a variety of equipment, maintenance, and engineering and construction services to the energy, industrial, and government sectors. Until recently, the company used to divide its operations into two broad business groups: the Energy Services Group (ESG) and Kellogg Brown & Root (KBR), a wholly owned subsidiary. In early April 2007, Halliburton completed the separation of KBR by exchanging 135.6 million shares of KBR, Inc. owned by it for 85.3 million of its own shares. The transaction enabled Halliburton to become a pure-play energy services company.

Following the separation, Halliburton had four businesses: Production Optimization (PO), Fluid Systems (FS), Drilling and Formation Evaluation (DFE), and Digital and Consulting Solutions (DCS), all of which originally belonged to the old ESG group. The two KBR segments have been reclassified as discontinued operations following the separation. The company recorded a net gain of $933 million related to the separation in the second quarter of 2007.

During the third quarter of 2007, Halliburton combined these businesses into two main segments: Completion and Production, and Drilling and Evaluation. The Completion and Production segment is comprised of completion tools, production enhancement, and cementing. The Drilling and Evaluation segment is comprised of Sperry Drilling Services, wireline and perforating services, Security DBS Drill Bits, Baroid Fluid Services, Landmark, and project management. In the first six months of 2008, the Completion and Production segment accounted for approximately 54% of the company's total revenue while the Drilling and Evaluation segment accounted for the remaining 46%.

While Halliburton shares have made some gains in the recent past, they still represent a compelling relative value in the large-cap oilfield service space, particularly following the removal of the KBR distraction. The stock trades at a significant discount to Schlumberger, Baker Hughes and other large-cap peers. This primarily reflects the lingering effects of weakness in the U.S. natural gas market, to which the company enjoys a strong leverage through its market leading position in the pressure pumping business. However, Halliburton is much more than just a pressure-pumping leader. It is among the top three players in each of the product/service category it offers and is present in all major hydrocarbon-producing regions of the world. Halliburton enjoys very strong relationships with both publicly traded and, increasingly more important, national oil companies worldwide.

The recent award of a major contract by Saudi Aramco to supply a range of oilfield services for the Manifa mega-project, which follows the award of the multi-year Khurais mega-project, highlights the company's strong relationships with national oil companies. The company s recent decision to split its headquarters between Houston and Dubai and to station its CEO in Dubai, highlight the growing significance of the region in its plans. In March this year, Halliburton inaugurated its sixth Eastern Hemisphere-based manufacturing center in Malaysia, augmenting the company s existing production facilities across North and Latin America, Europe and Asia. Last year, the Eastern Hemisphere accounted for over 40% of Halliburton's $15.3 billion oilfield services revenue. And this ratio is set to increase in the coming years, given the region's significantly higher growth prospects.

Halliburton has positively turned the corner by resolving the various issues that weighed on its prospects for quite some time. The asbestos issue has been resolved and the settlement trust has been funded. With the KBR in the back mirror now, Halliburton's strong leverage to the current cyclical upturn in oilfield-related activities is being more favorably viewed. Revenue and margins in the energy services operations are expected to continue benefiting from increased demand, driven by strong commodity prices. The company is particularly well positioned in the North American pressure pumping (part of the Production Optimization segment) business, where it remains the market leader. While this business has come under pressure recently due to a combination of excess supply and weak demand, its medium- to long-term outlook remains positive. While we do not expect any meaningful deceleration in activity levels, pricing power may remain under pressure in the near term.

Halliburton is also a major player in the directional drilling and wireline logging markets (part of Drilling and Formation Evaluation segment). Continued pricing gains in these different product categories should help sustain the improving trend in margins over the next few quarters. The company is also seeing strength in most of its international markets, as evident from a number of major project awards in the recent past. These include a cementing services contract from Statoil for $193 million, a $150 million contract to provide integrated drilling and well services to Drilling Production Technology in Norway, a $59 million contract from Russia's Rosneft for fracturing services in Siberia, a $73 million contract to provide stimulation services for Mexico's Pemex and a $100 million multi-services contract awarded by TNK-BP for work in the Tyumen region of Russia. More recently, the company has secured five major contract awards a multi-million dollar contract with Oil Search Ltd. to provide a full range of subsurface services in Papua New Guinea, a $270 million contract awarded by Petrobras to provide exploration and development testing services in high pressure, high temperature and deepwater environment, a 5-year contract valued at $200 million to provide completion products and services to a group of energy companies including PETRONAS Carigali, Exxon, Shell and Newfield for operations throughout Malaysia, a three-year, $683 million contract with Pemex to manage the drilling and completion of 58 land wells in southern Mexico, and a multi-million dollar contract with Rosneft-YNG associated with work on oil wells in Western Siberia.

Recently, the company won two significant contracts the $900 million Statoil completions work in the North Sea and the offshore portion of the Manifa project in Saudi Arabia. These awards not only provide Halliburton with incremental business in two of the company's major markets, but also solidify its position in the offshore markets. On the onshore front, the company recently secured a three-year contract by Abu Dhabi's national oil company to provide completion equipment for onshore oil and gas wells. Another major growth area for the company is Latin America, where revenue jumped more than 33% in the most recent quarter. As more projects come online during the year, this region's prospects are likely to improve further.

New technology is also important as a growing share of the company's revenue comes from new technologies. Halliburton won the 2007 Offshore Energy Achievement Award in Well Construction for its Sperry Drilling Services ReFlexRite multilateral system. This technology helps extend the productive lives of existing wells in mature fields in a cost-effective manner by converting a simple horizontal well into a multilateral well while simultaneously maintaining production from the original wellbore. Recently, the company s DBS Drill Bits added a breakthrough technology the XR reamer line of tools, which is designed for both conventional and rotary steerable applications, and provides the industry s only available concentric-hole enlargement technology. XR reamer tools offer activation and deactivation capabilities that allow the hole to be selectively enlarged based on existing casing-shoe and well-design parameters. In April, the company showcased four complementary fracture stimulation technologies (OmegaFracTM fluid, MonoPropTM proppant, the ADPTM or the advanced dry polymer blender, and the MimicTM fluid measuring device) that reduce operator s production costs by offering better recovery techniques compared to those achieved with conventional fracturing techniques. In recent times, the company has also won three engineering achievement awards for its Baroid Fluid Services' INTEGRADE diesel-based fluid system Sperry Drilling Services' InSite ADR Azimuthal Deep Resistivity sensor and Easywell's Swellpacker cable system.

Halliburton has also undertaken a number of joint development initiatives. The company's Landmark brand (a part of ESG) along with WellDynamics Inc. is developing the oil and gas industry's first integrated, model-based solutions for closed-loop optimization of intelligent wells, which will enable customers to execute decisions based on real-time well data. Landmark also announced a new cataloging and tapeless archiving solution designed to simplify and accelerate data archival and retrieval. Recently, Landmark introduced a new offering for powerful storage technologies to process seismic data at high input/output levels. The company and Grant Prideco recently interfaced their technologies and successfully tested a system using the IntelliServ Network, which will offer new drilling and formation evaluation capabilities. Other new products/services include the SandTrap service, used to assist operators with the economical recovery of bypassed hydrocarbons in weakly consolidated reservoir sands. DepthStar is performing well and continues to receive awards bringing recognition to the product. Landmark Graphics released an advancement that allows processing four times more information on any seismic study.

Halliburton has also been active on the acquisitions front. In its acquisition program, the company aims to plug product/service holes in its portfolio or increase its geographic footprint. In January 2007, the company acquired Calgary-based Ultraline Services Corporation, a division of Savanna Energy Services Corp for $180 million. This acquisition strengthens the company's position in the cased-hole wireline and production logging services. The acquisition augments the company's current suite of formation evaluation technologies and supports the growth of the wireline business globally. In July last year, the company completed its previously announced acquisition of PSL Energy Services Ltd., a leading Eastern Hemisphere provider of process, pipeline, and well intervention services. The acquisition fits in well with the company's growing focus on the Eastern Hemisphere. In May 2007, the company acquired Vector Magnetics' active ranging technology for Steam Assisted Gravity Drainage (SAGD) applications. This addition is in line with the company's strategy to expand into unconventional reserves capabilities that will allow it to offer a full range of drilling services to enhance production from heavy oil reservoirs around the globe.

And late last year, Halliburton completed the previously declared acquisition of OOO Burservice, a leading provider of directional drilling services in Russia. Recently, the company's Landmark unit, part of its drilling and evaluation segment, acquired Texas-based Knowledge Systems, a supplier of specialist geopressure modeling software. This acquisition gives Halliburton access to Knowledge System s geopressure and geomechanical modeling applications, which would complement its existing technologies and services in ensuring an optimal and economical drilling of the wells. More recently, Halliburton purchased the remaining 49% of WellDynamics (thus owning 100% of the company), the world's leading provider of intelligent well completion technology. The acquisition provides significant competitive advantage in delivering increased reservoir productivity and maximized ultimate recovery. Moreover, the company acquired the Protec Centerform, the only provider of casing centralization that uses a carbon, fiber, and ceramic composite applied directly to the casing. This complements Halliburton s range of casing solutions, particularly for its customers' deep water and high-pressure, high-temperature drilling and completion challenges.

We view all these acquisitions as major long-term positives, especially after the company's renewed status as a pure-play energy services company following the KBR split. Given the company's strong financial health (the company currently has a debt-to-capitalization ratio of approximately 25%), we see more of such acquisitive activities in the coming months. Management has also remained focused on returning cash to shareholders, which is evident from the recent hike in buyback authorization by $2 billion to $5 billion. The company has already used up approximately 60% of this authorization. Also in May last year, the company increased its quarterly dividend by 20% to $0.09 per share ($0.36 per share annualized).

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