Irenice takes a position at KBR. How Activism Can Improve Shareholder Value

Businesses: KBR provides scientific, technological and engineering solutions to governments and businesses around the world. The company operates in two segments: Government Solutions and Sustainable Technologies. Its Government Solutions (GS) business segment provides full life-cycle support solutions for defense, intelligence, space, aviation and other programs and missions for military and other government agencies in the United States, United Kingdom and Australia. Its Sustainable Technology Solutions (STS) business segment comprises process technologies that include ammonia/syngas/fertilizers, chemicals/petrochemicals, clean refining and circular process/circular economy solutions.

Stock Market Value: $7.91 million ($59.36 per share)

In recent weeks, government contractors, including KBR, have faced a sector-wide assessment in response to perceived risks associated with the incoming Trump administration. Investors are speculating that the new Department of Government Efficiency (DOGE), with its mandate to cut federal spending, has already compromised. cut $2 billion from the federal budget, there could be a significant decline in the profitability of government contractors. As a result, between Election Day and Irenic’s announcement that it had built a position in the company, KBR shares fell more than 18%. However, KBR may be properly punished for DOGE’s speculation. In reality, KBR is more insulated from these threats than the market currently perceives. First, while the company’s GS business accounts for 75% of KBR’s revenue, it contributed less than half of its operating income in FY23. Additionally, 25% of GS business is international, mainly in the UK, shielded from potential DOGE implications. Looking at the remaining 75% of that U.S. market segment, detailed analysis reveals that only a relatively small portion of KBR’s services are subject to estimated related cost pressures. While many things are currently in doubt, the threats to the GS segment seem, at this point, to be overblown. Additionally, the STS segment can benefit from the incoming administration plans. Under the Biden administration, there was a moratorium on export permits for LNG plants and several projects were halted. The Trump administration plans to reverse that, which could be a windfall for KBR, as the company is well-positioned to win new and existing projects.

Perhaps after KBR’s discounted valuation after the recent exogenous share price shock, Irenic has now come in. Irenic has accumulated a position of more than 1% in the company and is asking management to separate the STS segment. They are essentially different businesses with different support needs, management requirements and end markets. Companies that are not together must be separated for several reasons: (i) each can attract the corresponding shareholder base and assign the corresponding multiple; (ii) each can offer management focus and compensation to be more aligned with specific business needs; and (iii) the separation may result in a reduction in corporate overheads, creating leaner and more efficient entities. KBR currently trades at 11.5 times trailing 12-month adjusted EBITDA. Looking at peer companies, GS’s typically trade in this range, but most like STS fetch an average multiple of 14-15 times EBITDA. Separating the two would require revaluing the STS business creating value for shareholders before any cost savings from the separation. Separating the two businesses would eliminate the need for many of the corporate costs the company currently incurs, which would save the bottom line $50 million. Finally, before any value is created, the company may buy back shares to create additional shareholder value. While each value creation lever is not very compelling on its own, the combination can result in a 50% increase in shareholder value.

Irenic is not the only shareholder who thinks that a separation makes sense; Many other shareholders share this opinion. In other words: keeping the two companies together makes no sense. A few years ago, it would have been fair to argue that an STS spin-off was not feasible due to the size and youth of the unit. In 2021, the segment posted an operating loss of $30 million and in subsequent years, management successfully made this argument that the segment needed to be bigger to make an impact. But STS now generates about $400 million in EBITDA, and it’s time for management to walk the walk. Irenic enjoys working behind the scenes with management and using the power of persuasion to win the day. We expect the company to do so here until KBR announces a strategic review or the company’s appointment deadline of February 14, 2025, whichever comes first. If no proper announcement is made by February 14th, we’d expect Irenic to do something he’s never had to do before: start a proxy fight. However, given shareholder support for a separation and a vacant board seat (Gen. Lester L. Lyles recently announced (He will retire from the board after the 2025 annual meeting) we don’t expect that to happen. If an Irenic board seat is awarded, it will likely be for an independent director with significant industry experience, as opposed to an Irenic director.

If KBR is undertaking a strategic review, we would be remiss if we did not mention a similar and important situation. Elliott Investment Management has defended recently Honeywell to split into two companies, and Honeywell later announced strategic review from his businesses. Honeywell may be a potential strategic acquirer of parts or whole of KBR. Irenic’s co-founder, Adam Katz, was a former employee of Elliott Investment Management, and I’m sure he still knows people there.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of 13D activist investments.