More Problems Upstage Friede Goldman's Merger With Halter Marine

Friede Goldman may have to take charges against third-quarter earnings. Its problems stem from construction delays and possible fines.
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More disappointments are on the way for

Friede Goldman

(FGI)

investors as the company tries to close its merger with

Halter Marine

(HLX) - Get Report

.

In a registration statement filed with the

Securities and Exchange Commission

late Monday, Friede discloses that it may take a third-quarter earnings charge stemming from its ongoing dispute with Norway's

Ocean Rig

over construction delays for two semisubmersible rigs. In addition, it's unlikely Friede will meet minimum man-hour requirements this year at its Canadian subsidiary. If so, Friede will have to pay the Canadian government a penalty of about $3.5 million on a pretax basis, the document says. Analysts say Friede may set up a reserve for this fine in the third quarter.

Friede didn't return calls seeking comment.

Separately, the SEC documents disclosed that Friede and Halter expect to save $15 million on a pro-forma basis (or as if the merger had already occurred) this year and another $15 million next year after they merge to form

Friede Goldman Halter

. Shareholder meetings to vote on the merger are set for Oct. 28.

The possible charges would add to a year of frustration for Friede shareholders. Jackson, Miss.-based Friede, known for its rig-building and design prowess, has seen its backlog drop precipitously. One possible customer has been unable to secure financing for a rig-building project that would add another $143.5 million to Friede's backlog. Then there's the Ocean Rig dispute. Most recently, the company was forced to amend its acquisition agreement with Halter. Halter shareholders will now receive 0.57 shares of Friede stock in exchange for each Halter share. That ratio originally was 0.4614. And Friede's shares have plummeted 46% since May. Friede was trading at 10 3/4, up 3/8, Wednesday afternoon.

The Canadian fine "is more important because that is surprising and out of the blue," says Poe Fratt, who follows Friede at

A.G. Edwards

in St. Louis. "The market should know about Ocean Rig and the possibility they'd have to take a charge to back out some of the profit and fixed-cost absorption. But the surprise is they have 1.2 million man-hours they might not be able to book up in Canada, and they are not getting enough work."

When Friede purchased the facilities in Newfoundland in early 1998, it agreed to maintain a minimum of 1.2 million man-hours a year from 1998 through 2000. In exchange, the Canadian government sold Friede the shipyard for $1. At June 30, 459,000 man-hours had been booked. FGI may just pay a fine this year while pushing other projects into next year to meet that minimum, Fratt says. The fine works out to about 10 cents per share on an after-tax basis, he adds. Current

First Call/Thomson Financial

estimates see Friede earning 22 cents for the third quarter and $1.22 for the year.

The Canadian fine is not a huge setback, Fratt points out, due to the bargain purchase price. It's simply "turned from a great deal to a so-so deal," he says. Fratt has a buy rating on the stock; A.G. Edwards hasn't participated in underwriting for Friede.

More uncertain for Friede is the Ocean Rig dispute. It stems from construction delays, which Friede asserts were initiated by Ocean Rig. Ocean Rig claims it's Friede's fault.

If the Ocean Rig dispute isn't resolved before FGI reports its earnings in late October, it would recognize as revenue only its direct costs associated with the two rigs it's building for Ocean Rig. It would charge off the fixed costs and related revenue it would typically place in the quarter under its percentage of completion accounting. It estimates these charges could be 20 cents to 30 cents per share on an after-tax basis.

"Some

uncertainty is reflected in the stock, but we really don't know how much," says Brent Rakers, who follows Friede at

Morgan Keegan

in Memphis, Tenn. "I don't think there's material upside until they get beyond all these things." Rakers rates FGI market perform; his firm hasn't performed underwriting for Friede.

But Rakers also stresses the opportunity for the new company. It may actually have a whole new market in addition to rigs and boats, Rakers says. Floating, production, storage and offloading vessels allow for deep-water production in areas with little or no infrastructure. Although they're not permitted in the Gulf of Mexico, the rules may change over the next year or two.