Is it war profiteering if you barely make a profit on your war work?
In March 2003, the KBR unit of Halliburton, the oil-services company formerly run by Vice President Dick Cheney, controversially received huge no-bid contracts to provide a range of services in Iraq—everything from fixing oil fields to delivering fuel to feeding soldiers. For many administration critics, KBR's central role in the reconstruction of Iraq stands as evidence that the war in Iraq was a pretext for crony capitalists to grow fat on borrowed taxpayer dollars.
But here's the funny thing. So far, the Iraq war hasn't proved much of a boon for Halliburton's shareholders. Because of incompetence, the chaos of working in the war zone, and a contract that limits profits, KBR's margins on its hazardous work are pretty marginal.
The Wall Street Journal notes that the Iraq contracts call for KBR to be reimbursed for its costs plus 1 percent. The company can also bill the military for a portion of its administration and overhead and can earn performance bonuses. KBR spends a lot of effort funneling taxpayer money to subcontractors, who may themselves be getting rich off of Iraq-related work. Meanwhile, the Iraq work has required KBR to incur big expenses of its own—higher insurance costs for operating in a hazardous region, recruiting costs for hiring new employees for dangerous duty, and administrative costs for handling a huge amount of new business quickly.
An excellent front-page article in yesterday's Wall Street Journal by Russell Gold shows that, depending on how you look at it, KBR has either made the best of a horrible situation or has screwed up big time. At times, KBR seems to function more like a dot-com on its last legs than the ultra-efficient logistics unit of a Fortune 500 company. Suppliers don't get paid and invoices are routinely lost. As KBR rushed into Iraq, "Many of its systems, from procurement to billing, got overloaded, creating a breeding ground for potential corruption and more inflated prices—not to mention inefficiency on a huge scale," Gold writes.
When you're a logistics company—and one working on a 1 percent profit margin—inefficiency is a killer. That's why for service companies like Halliburton, landing huge contracts is less than half the battle. Improperly executed, a huge contract can become a gigantic liability. So while KBR may land deals because of its connections and experience, it hasn't shown much ability of late to carry them out profitably.
According to Halliburton's most recent quarterly results, released yesterday, its KBR unit lost $15 million in the first quarter, largely because of a $97 million loss on an ill-fated project in Brazil, even though revenues for the unit doubled to $3.7 billion. Iraq was a fairly dim bright light. "Halliburton's Iraq-related work contributed approximately $2.1 billion in revenues in the first quarter 2004 and $32 million in operating income," the company reported. That's a margin of 1.5 percent.
The previous quarter, KBR reported $2.2 billion in Iraq-related revenues and operating income of $44 million—a 2 percent margin. And in the third quarter of 2003, KBR had $900 million in Iraq revenues and operating income of $34 million—a 3.7 percent margin. As time goes on, in other words, KBR's profits in Iraq are shrinking in both real and proportional terms. Worse, for KBR, this may be as good as it gets.Even though it received a $1.2 billion contract from the U.S. Army Corps of Engineers to continue working on the Restore Iraqi Oil program in January, the unit's backlog of work has shrunk.
What's more, KBR may ultimately pay the price for its success in monopolizing Pentagon business in Iraq. Halliburton and the Pentagon have become dependent on each other, and that may be bad for both of them. It would be extremely difficult for the Pentagon to switch master contractors in the middle of a war. And for Halliburton, the Pentagon may prove to be a capricious, highly demanding, and unpredictable client.
KBR is now under criminal investigation by the Pentagon over claims it overcharged for fuel delivered from Kuwait. The Pentagon is also looking into dining-hall contracts allegedly awarded without competitive bids. And annoyed at repeated billing screw-ups, the Pentagon is withholding hundreds of millions of dollars in payments to KBR. Any of these conflicts could further erode KBR's margins.
KBR hasn't lost money on its sweetheart Iraq contracts—yet. It has made a small profit. But the amounts are nothing to write home about—and they're certainly not worth starting a war over.