Pentagon Audit Takes Aim at Halliburton

The energy services firm faces more questions on its billing practices in Iraq.
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has taken another hit over its work in war-torn Iraq.

The company's KBR unit now stands accused of improperly accounting for some 43% of the $4.18 billion it has so far billed the government for projects in the Middle East,

The Wall Street Journal

reported on Wednesday. The company has until Sunday -- a deadline already twice extended -- to justify its billings or risk losing 15% of its payments, the



Government officials outlined their complaints in a new 60-page audit described by the


as "the most serious critique to date" of KBR's billing for services provided to U.S. troops in Iraq.

"The audit found that KBR's 'internal control policies' are 'inadequate for providing verifiable, supportable and documented cost estimates that are acceptable for negotiating a fair and reasonable price,'" the


reported, citing the nonpublic report. "Pentagon officials said that no defense contractor has had its estimating system ruled 'inadequate' in years."

Halliburton spokeswoman Wendy Hall said the company disagrees with both the report and the conclusions that

The Wall Street Journal

reached about it. She insisted that Halliburton employs proper billing procedures and maintained that the audit actually has nothing to do with the amounts charged by Halliburton or, in turn, the sums that it can expect to recover. Instead, she described the audit as a normal part of negotiations with the government.

"Normally, these kinds of audit reports are part of a lengthy but routine process that is amicably resolved," she said. "Only in an election year -- when Halliburton is being covered in a political context as opposed to business -- does a

Defense Contract Audit Agency audit dispute become a news story."

By now, Halliburton has spent more than a year under fire for its past ties to Vice President Dick Cheney. Critics point to Cheney -- Halliburton's former CEO -- as the reason the company won so many big contracts in Iraq in the first place. And they have accused the company of profiting handsomely from the war there.

Even before the latest audit, the government was questioning whether KBR may have charged too much to feed U.S. soldiers and obtain fuel from Kuwait. But Wall Street analysts have largely downplayed the allegations and maintained their bullish stand on the stock.

Indeed, UBS analyst James Stone was quick to defend the company on Wednesday. He called the new government complaints "impractical" and went on to say that Halliburton enjoys continued support from its actual customer in Iraq, the Army Material Command. Thus, he dismissed the latest headlines as little more than "the same old song."

Meanwhile, Wachovia analyst Brad Handler on Wednesday initiated coverage of Halliburton with an outperform rating even as news of the Pentagon audit broke. Handler listed negative headlines as the "obvious" risk to his thesis. But he is nevertheless convinced that Halliburton will weather the storm and generate strong returns for its investors in the end.

"Behind the headline smoke, we see little financial fire," Handler wrote on Wednesday. "We have found KBR's rebuttals to accusations levied at it convincing."

Handler instead directed investors to focus on Halliburton's energy services business. He pointed to Halliburton as the leader in a pressure pumping business that, due to tightening capacity for pumping equipment in the U.S., could enjoy a nice pop. He also noted that Halliburton is a "relatively quiet No. 2" service provider, trailing only


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, in the expanding oil markets of both Mexico and Russia. He even offered a positive outlook for the company's troubled KBR unit.

"We expect the headlines surrounding Halliburton to subside" after November's election, he explained. "And we continue to believe that KBR's Iraq work should yield some upside starting in Q4 2004 and into 2005."

But Gimme Credit analyst Carol Levenson is far more cautious. She pointed to KBR -- ncluding its billing disputes with the government -- as a serious threat to the company overall.

She insisted that "Halliburton's legendary financial strength has diminished markedly." And she continues to steer investors away from the company's debt.

"The company has some crucial liquidity maneuvers to negotiate to extend its expiring credit facility and obtain an additional securitization facility for KBR's government receivables," she wrote. "We don't believe current spreads adequately compensate investors for these risks."