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Asbestos Verdict Tarnishes Halliburton's Future

For Halliburton (HAL - Get Report), a small-town jury verdict may redefine the nature of asbestos litigation.

A Lexington, Miss., jury on Oct. 27 ordered Halliburton's Dresser Industries, Minnesota Mining & Manufacturing (MMM - Get Report) and AC&S, a former pipe-insulation contractor, to pay six plaintiffs $25 million each, a total of $150 million.

The plaintiffs -- ranging in age from 55 to 80 -- were exposed to asbestos in the 1950s while working around boiler rooms and pipes in shipyards and schools. Dresser is an engineering and construction company that used certain asbestos products, and 3M manufactured safety masks that the jury found did not adequately protect workers from asbestos exposure. The jury was convinced the defendants were aware of the potential health risks of asbestos decades before the plaintiffs came into contact with the material.

"We were able to show these manufacturers knew as far back as the 1920s and 1930s about the risks, didn't warn the public of it and set out to conceal it from them," Isaac Byrd, an attorney for the plaintiffs, told the Jackson Clarion-Ledger. "I think it's the largest compensatory damage award for asbestos exposure in the nation."

Both Halliburton and 3M indicated they would appeal the verdict. Even so, Halliburton claims its potential responsibility in the award is only $21.25 million, while 3M says its potential liability is just over $22 million. Halliburton notes that the jury awarded only compensatory damages, not punitive damages.

A New and Present Danger

Regardless of what happens in the appeals process, this jury verdict is likely to signal to other plaintiffs' attorneys that the probability of winning a jury trial is better than once thought. Combined with a recent jury verdict in a Texas asbestos case, which awarded five plaintiffs $65 million, the Mississippi verdict puts momentum on the side of more trials and fewer settlements.

Since 1976, Halliburton has received nearly 300,000 claims related to asbestos injuries. According to public filings, the company has settled 171,000 claims for about $127 million -- with all but $33 million covered by insurance.

However, the news of a $100 million-plus verdict will probably lead to more litigation, raising uncertainty about the future of the energy-services giant.

"The settlements to date have been minuscule, but this verdict changes everything," says Bryan Dutt, portfolio manager at Ironman Energy Capital, a Houston-based energy investment firm, and a member of the TSC Energy Roundtable. "This verdict blows settlements out of the water. They could be looking at tens of thousands of lawsuits, and as verdicts rise, the suits get bigger and the lawyers get better." Dutt is currently short Halliburton shares.

Merrill Lynch energy analyst Kevin Simpson calculated that until this verdict, the average settlement had cost the company $758, but he notes, "This cost has been slowly but steadily increasing." With this verdict, the rate increases dramatically. Simpson rates Halliburton accumulate, and his firm has provided banking services for the company.

Though Halliburton has so far been able to cover most settlements with insurance proceeds, continued insurance coverage becomes less certain if trials and verdicts snowball. "You can't be sure the insurance claims are going to remain good," notes one analyst who wished not to be identified. "This problem and the insurance mess probably get much larger." Halliburton is currently litigating certain asbestos-claim issues with insurance carriers.

Simpson had estimated -- before the Mississippi verdict -- that the worst-case scenario would cost Halliburton $840 million to settle all outstanding claims, before any insurance coverage. "Ignoring the time value of money, this would cost Halliburton shareholders about $2 per share," he noted.

However, even Halliburton bulls fear that an avalanche of litigation could cause mounting pressure on the energy-services giant. "The company always runs the risk of losing and being hurt with a large jury award," wrote UBS Warburg energy analyst James Stone in a recent report. "[S]everal instances such as this could put more pressure on the stock price and add to Halliburton's liability." Stone rates Halliburton a strong buy, and his firm has provided banking services to the company.

Stone had recently estimated -- again, before the Mississippi verdict -- that the net present value of Halliburton's total liability ranged from $409 million to $636 million, or 98 cents to $1.48 per share, which he said was manageable. "Even under our 'high-case' forecast, we do not expect the annual cost of the liability straining Halliburton's finances or liquidity to the point at which Halliburton would seek bankruptcy protection," he wrote.

The latest verdict may change that perception. "It may be grossly unfair to Halliburton and the other parties," says Dutt, "but this is the kind of ruling that has led to the demise of companies. It's not fair, it's not right, but it is the way things can go."

Analyst Blinders

While Halliburton's asbestos problems are worsening, analysts will probably be low key when it comes to criticizing the company as investment banks court its business.

Halliburton's new chief financial officer, Doug Foshee, has been acquainting himself with the Street and letting analysts and bankers know that Halliburton's investment-banking business is up for grabs.

With such high stakes, analysts may treat Halliburton with kid gloves. "The sell side will be sucking kneecaps because of the investment-banking opportunities," says the analyst. "What's the benefit in being negative about asbestos and ticking off your investment bankers? There is a lot of business on the line."

Warburg Dillon Reed, now known as UBS Warburg, and Goldman Sachs advised Halliburton on its merger with Dresser. However, sources say the company is upset with both firms, claiming that they didn't adequately flag Dresser's asbestos liability when it was acquired in 1998.

So don't expect big play on the asbestos issue from the sell side. "It's not seeing the light of day because there are very few people that have an incentive to get aggressive," the analyst says.

That didn't stop Merrill's Simpson from pointing out the potential risk for Halliburton shareholders. "The asbestos liability may be costing Halliburton roughly $6 to $10 per share based on its relative valuation to its large-cap peers," he notes. "While the asbestos liability is arguably overdiscounted in the shares, whenever these issues flare, the shares underperform and it will take a very long time -- years not quarters -- to resolve."

This is one of those times.
Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, Edmonds' firm had no positions in any of the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to Chris Edmonds.

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