Accounting Problem Drills Baker Hughes Where It Counts: Credibility

In case there was any doubt, the newly unearthed accounting problems clinch it: Baker Hughes (BHI) has a management credibility problem.

The accounting news, disclosed Wednesday night, drove Baker shares down 3 1/4, or 14%, to close Thursday at 19 1/4. The announcement comes a week after Baker warned of a fourth-quarter operating loss, and is the latest in a series of missteps that have left Baker stock up just 10% for the year even as oil and other oil-related stocks have rallied sharply.

Bad Week

Earlier this year, Houston-based Baker unveiled a set of plans that had some on Wall Street hoping management had overcome its problems. But the latest disclosure underscores that it hasn't, and pressure from the board to make changes will likely follow, says an industry consultant who spoke on the condition of anonymity.

"This could not have come at a worse time for this management team," says a Houston-based analyst who declined to be named. Baker's largest shareholders "are exceedingly concerned about the competence of the current chief executive," he says, referring to Max Lukens, Baker's chairman, president and chief executive. His firm recommends the stock but hasn't underwritten for Baker.

Gary Flaharty, a Baker spokesman, says the accounting issues span several years and are isolated at Inteq, a large unit that provides drilling fluid and directional drilling services to oil companies. Flaharty declined to comment on actions the board could take, but says Baker "takes the loss of credibility seriously and we want to do everything we can to respond credibly to the investment community."

Could Have Been Worse Baker shares open weak Thursday but begin to recover

Source: BigCharts

As a result of the accounting problem, Baker will shelve a $200 million debt refinancing that was scheduled to close Friday. Instead, it will seek short-term debt, Flaharty says. That will likely push up Baker's interest rate, though the setback isn't expected to cause liquidity problems. The hit to earnings from the accounting problems will amount to $40 million to $50 million, or about 9 cents per share.

Schroder's, Goldman Sachs and Morgan Stanley Dean Witter downgraded Baker's stock Thursday, pushing it down 25% at the open on extremely heavy volume before a later retracement.

Value Subtracted

Robert Trace, who follows Baker at SouthCoast Capital in Houston, says that at a March analyst meeting Baker "informed the Street they were going to become a lean, mean fighting machine," and the stock ran up as a result, outperforming peers in the ensuing months.

The companywide program, dubbed "Baker-Value-Added," aimed to boost profitability by increasing management accountability. As late as August, some investors gave Baker the benefit of the doubt, saying it was undervalued relative to its rivals Schlumberger (SLB) and Halliburton (HAL).

But in reality, management wasn't executing. "In the back half of the year, they've fallen apart," says Trace at SouthCoast. He adds that Wednesday's news "is clearly proof that there were more problems at the company than just at Western Atlas," which Baker acquired last year. Last week Baker set a $130 million charge to write down certain seismic assets. (Trace rates the stock hold, and SouthCoast hasn't underwritten for Baker.)

This problem "begs the question are your systems and reporting guidelines reliable," adds Bill Herbert, co-head of oil service research at Simmons, a Houston investment bank focused on energy. (Simmons doesn't rate individual stocks; it hasn't performed any recent underwriting for Baker.)

Although no one disputes the quality of Baker's assets and its No. 1 position in several oil-service segments, the cloud over the company's management has grown bigger and blacker in recent weeks. Because of that, it will likely be buffeted about in the volatile sector.

And until Baker's outside auditors sign off, investors "will likely continue to be suspicious of management," says Wes Maat, who follows the sector at Deutsche Banc Alex. Brown in New York. He kept his market perform rating on the stock, though he suspended his price target of 33. "We see the stock bobbing and weaving for a while," he concludes.

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