War profiteering—harder than it looks.

Commentary about business and finance.
April 24 2006 5:48 PM

Lament of the Profiteer

Why Halliburton wants the Iraq war to end.

Waving the KBR banner. 
Click image to expand.
Waving the KBR banner

Two years ago, Moneybox marveled at how Halliburton unit KBR was failing miserably in its attempts to profiteer on the Iraq war, an adventure spurred on in large part by former Halliburton CEO and current U.S. Vice President Dick Cheney.

They're getting somewhat better. Earlier this month, Halliburton filed to sell a 20 percent stake of KBR to the public. And the prospectus gives new insight into how KBR is doing managing the gigantic no-bid logistics and support contracts it received from the Pentagon. The April 14 filing suggests KBR is more skilled at profiting off the war.

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KBR sells itself as "a leading global engineering, construction and services company supporting the energy, petrochemicals, government services and civil infrastructure sectors." The company operates through two business units: Energy and Chemicals (E&C), which builds oil platforms and liquefied natural gas terminals, and Government and Infrastructure (G&I)—i.e., defense contracting.

But these are nowhere near equal partners. KBR has several key defense contracts, including the massive open-ended master Iraq contract, known as LogCAP III, plus mandates to restore Iraq's oil fields. KBR's five-year financial data (Page 43) show that revenues have exploded thanks to the post-9/11 wars, from $5.1 billion in 2002 to $10.1 billion in 2005—about half of all Halliburton revenues. The G&I business accounted for virtually all of the growth. The unit accounted for 61 percent of the company's revenues in 2003 and 80 percent of revenues in 2005. The Middle East alone accounted for $6 billion of KBR's 2005 revenues.

KBR has finally figured out how to make profits on all that war cash—although not that much. The G&I sector reported operating income of $331 million in 2005, nearly four times the 2004 figure. Subtract a $96 million gain from the sale of a stake in a toll road, and operating income was about 3 percent of the unit's revenues. (KBR's large defense contracts are so-called "cost-reimbursable contracts," where the firm gets a fixed profit percentage plus the ability to earn a bonus based on performance.)

But KBR's best war years may be behind it. KBR's overall revenues fell $1.8 billion in 2005, in large part because Iraq-related revenue fell to $5.4 billion from $7.1 billion. And Iraq-related revenue is expected to fall again in 2006 as the United States silently winds down reconstruction efforts. Worse, the next big master contract (LogCAP IV) is going to be put out for competitive bid, which means KBR, which won the current master contract as a result of a no-bid process, might not get renewed.

Like war architect Paul Wolfowitz, now ensconced at the World Bank, KBR is trying to move beyond Iraq. It's pushing its petrochemical business and downplaying its war work. Of the eight images on the cover of the prospectus, only one—of what appears to be a large mess hall—seems to show Iraq. The prospectus notes that at the end of last year, the firm's $10.6 billion order backlog was split between E&C (51 percent) and G&I (49 percent). But by the end of 2006, according to company estimates, only one-third of KBR's future business will be in defense contracting—(assuming, that is, it lands no gigantic contracts in the next several months). Recent KBR releases have pointed investors' attention to its activities in the wonderful world of petrochemicals, like building an ammonia plant in Egypt, or to less-troubling defense-related items, like providing emergency support for the Department of Homeland Security.

All of which may be good news for shareholders. Because, as experience shows, having a near monopoly on Pentagon business in Iraq—and powerful patrons in the White House—doesn't guarantee profits or protect you from scrutiny. The risk section of the prospectus, which reads more like a John le Carré novel than a financial document, reveals what KBR is fighting over with the Defense Department: $12 million in costs relating to laundry services in southern Iraq, $51 million on "certain costs associated with providing containerized housing" in Iraq, and $69 million in unspecified "unapproved claims." Then there are various investigations into graft and corruption on the part of former employees, and lawsuits filed by families of truck drivers who were killed in an ambush in Iraq and by workers who claim that KBR didn't properly pay overtime. And members of Congress have complained about the quality of water provided by KBR at Ar Ramadi in Iraq. (And all that is before we get to the bit about alleged bribes connected to natural gas in Nigeria.)

So, should you buy KBR's stock? The margins aren't great, its sweetheart contracts may be a thing of the past, and its patrons are in decline. But hey, that's all history. And stocks are famously about the future. Dick Cheney may be gone from the scene in 2008. But his legacy—the occupation of Iraq, the outsourcing of vital government functions, and higher energy prices fueled in part by global instability and a refusal to commit to conservation—will last long beyond that. What's more, KBR—the Constant Contractor—has achieved a perfect synergy between its diversified businesses. Global instability and American war policies boost demand for its logistics and support services in Iraq. These policies also help keep energy prices high, which stimulates investment in the oil, gas, and petrochemical sectors. KBR's stock is, in effect, a leveraged bet on the Bush administration's continued incompetence at dealing with the twin issues of energy security and the Middle East.

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