Oil and Gas Equipment & Services

1. Oil and Gas Equipment & Services Halliburton: Final Valuation & Recommendation Jeff Ritter

2. Agenda Financial Statements Reformulation Forecasts Valuation Models Buy/Sell/ Hold Recommendation

3. World’s Largest Oil Field Company

4. What does Halliburton do? • Using the latest geological technologies, Halliburton creates data that helps their customers locate oil and natural gas. • When hydrocarbons are located, they provide solutions to determine if oil and gas can be produced. • If a well is determined to be viable, they provide the services that allow oil and gas companies to begin production. Throughout the life of the field, they help their customers maximize production and recovery, and they help them realize reserves from difficult geologic environments. • Halliburton provides well intervention, pressure control, and pipeline and process services.

6. Expanded Financial Statements Red=Eliminated from the financial statements and not included in calculations Green=Added to financial statements and included in calculations

7. Expanded Financial Statements Red=Eliminated from the financial statements or just shown as explanation and not included in calculations Green=Added to financial statements and included in calculations

8. Rent Expense is backed out and not double counted

9. Reformulation* Revisited and More Complete Analysis *Focus on changes as compared to Module 2

10. EPAT and NEA B/S Enterprise Operations Reformulation Financing I/S “Is the element part of enterprise operations or financing activities of Halliburton?” • Net Enterprise Assets (NEA) • Identify enterprise assets and liabilities • Net Financial Liabilities (NFL) • Enterprise Profit After Tax (EPAT) • Financing Expense After Tax (FEAT)

11. Mod 11 Operating Lease: Rent Expense separated into Depreciation Expense and Interest Expense Added in Module 11

12. Additional Interest expense in Module 11 operating lease Added in Module 10 & 11

15. Checking my work

16. Checking my work

17. Full-Information forecasting

18. Goal Right Answer Enter into debate about assumptions Demonstrate the process by which forecasting toward valuation can be done and the decisions involved Must rely on assumptions

19. Overview of the Forecast Process Trade off: Dependent on the firms business model. Forecasting relies on enterprise items that we expect to persist. Sales Growth Enterprise profit margin (EPM) Enterprise asset turnover (EATO) RNEA

20. Forecasting Sales Revenue • Most crucial and difficult estimate • All other enterprise income statement and B/S accounts derive directly or indirectly • Both EPAT and NEA change with with revenue • Use all available and relevant information • Unit volume growth, price, and mix are not disclosed and not as important because Halliburton’s revenue primarily consists of service based revenue • The explicit language in the earnings call regarding revenue was based on the company as a whole rather than segments. This limits the ability to forecast the two segments of sales accurately so forecasts of sales growth will still be based on the whole company.

21. Factors considered in Sales Growth Estimate • Historical sales growth • Halliburton • Comparables • Analyst Expectations • High, Low, and consensus estimates: 2013, 2014, 2015 • Oil Rig Counts • Oil Prices and Demand • Public Statements by management: Earnings Call and 10-K • “Mid to high single digit customer spending growth”

22. Volatile Historical Sales Growth

23. Analyst Expectations for Halliburton

24. Rig and Well Counts “Despite the decreased rig count in the United States as compared to 2012, drilling efficiencies and the trend toward multi-well pads are driving a more robust well count. Additionally, operators have been, in some cases, increasing the numbers of hydraulic fracturing stages on horizontal wells.” -Halliburton 10-K

26. Halliburton 10-K Support “Activity levels within our business segments are significantly impacted by spending on upstream exploration, development, and production programs by our customers. Also impacting our activity is the status of the global economy, which impacts oil and natural gas consumption. Some of the more significant determinants of current and future spending levels of our customers are oil and natural gas prices, the world economy, the availability of credit, government regulation, and global stability, which together drive worldwide drilling activity. Our financial performance is significantly affected by oil and natural gas prices and worldwide rig activity. Additionally, due to improved drilling and completion efficiencies as more of our customers move to multi-well pad drilling, our financial performance is impacted by well count in the North America market.” – Halliburton 10-K

27. Click audio Icon to listen to clips of actual Earnings Call Earnings Call “We're optimistic about the activity outlook for 2014 and will continue to be relentlessly focused on our cost structure to enable margin growth in the coming year.” “Let me begin by saying that we are very optimistic about the coming year in our ability to achieve robust revenue and operating income growth for the total Company.” “Based on customer surveys and some discussions with customers, we see total customer drilling and completion spending increasing by the mid to upper single-digit percentages” “Revenue growth for the full year could approach double digits.” “Expanding share in deep water market” Q4 2013

28. Earnings Call- April 21,2014 “I am optimistic about our ability to grow our North America revenue and margins, and to realize industry-leading revenue and margin growth in our international business” – Halliburton CEO

29. Sales Growth Assumption Historical growth for Halliburton and the Industry Rig and Well Count Ex: New construction Oil and Natural Gas Price & Supply/Demand Factors Historical growth has been volatile, but growth seems to relate closely to rig and well count. Oil prices and demand continue to increase, but energy efficiency has slowed the consumption growth in countries such as China. Total rig count declined dropping 10% from 2012 to 2013. Analysts expect it to begin to increase with the price of oil. 8.9%* Continuing 3 % Includes GDP Growth 3% and inflation considerations *Decreased by 10% each year for five years

30. Changes from Prior Sales Growth Forecast Original Assumption New Assumption 7.3% 8.9%* *Decreased by 10% each year for five years New information supports raising the initial sales growth.

32. Pro forma Income statements are in the Excel Spreadsheet.

33. “We're optimistic about the activity outlook for 2014 and will continue to be relentlessly focused on our cost structure to enable margin growth in the coming year.” –Halliburton Q4 2013 Earnings Call “…moving towards a more efficient cost structure…” -10-K Halliburton • Forecast Recommendation • Slight reduction in Cost of Services, which was volatile the last three years. This decision supports managements statements. • Slight reduction in Cost of Sales. Cost of sales increased by 1% of sales for 2011, 2012, and 2013. Management mentioned this concern and the expectation is that it will slightly decrease as Halliburton improves processes.

34. This loss contingency was a one time event and not reoccuring. The expectation is this contingency will be resolved in the near future. In 2013, Halliburton recorded a large contingency of 1 billion in regards to the Macondo Oil Spill litigation.

35. Research and development as a percentage of sales stayed constant 2011 to 2012, but rose from 1.61% to 2% from 2012 to 2013. The expectation is that R&D will remain steady at the increased rate of 2% with a slight increase in 2015. The new rate and slight increase are due to the necessity of researching new methods of oil discovery and extraction.

36. Provision for income taxes has varied during the past 3 years from 2%(2013) to 5.8% (2011). This is the most volatile expense in Halliburton’s EPAT. The percentage will increase due to macroeconomic factors and the governments pursuit to reduce tax breaks for oil and gas companies.

37. Discontinued operations by definition is not an ongoing item and is not expected to reoccur. The amount was trivial in the last three years. 2013 = .06% of revenue.

38. EATO

39. Pro forma Income statements are in the Excel Spreadsheet.

41. Pro forma Income statements are in the Excel Spreadsheet.

42. Receivables have steadily increased from 19.9% in 2011 to 21.4% in 2013. This trend is expected to continue as Halliburton focuses on expanding international operations. Sales may be made on credit in order to facilitate the penetration of international markets. In 2013, Halliburton revenue from other countries exceeded revenue from the United States, while in 2012 and 2011 United States revenue exceeded other countries.

43. Inventory accounts were stable in recent years except for for gross finished products and parts. This account increased from 7.7% in 2011 to 8.7% in 2013. The expectation is the account may continue to slightly increase over the next few years as Halliburton prepares to bolster finished products inventory for continued international expansion.

44. Growth internationally will require additional investment in property plant and equipment. Machine and equipmentincreased from 55.8% in 2011 to 60.9% in 2013. The expectation is this account will continue to increase over the next three years. This equipment is significant in the Oil and Gas Service Industry because in order to expand, Halliburton must have the necessary amount of equipment to meet and perform service requests for customers.

45. Prepaid expenses and other asset accounts are assumed to stay approximately at 2013 levels because of the consistency in prior years and no information within the 10-K or earnings call indicates a material change in the future. • Capitalized lease assets were very stable over recent years and that trend is expected to continue.

46. All enterprise liability accounts have been stable over the recent years making forecasts straightforward.

47. New Assumptions

48. Valuation Models Discounted Cash Flows Residual Enterprise Income Abnormal Enterprise Income Growth 9.43% WACC used from prior module.

49. Steady State

50. Steady State