Business: KBR It provides scientific, technological and engineering solutions to governments and companies around the world. The company operates through two segments: Government Solutions and Sustainable Technology Solutions. Its Government Solutions (GS) business segment provides full lifecycle support solutions for defense, intelligence, space, aviation and other programs and missions for military and other government agencies in the United States, the United Kingdom and Australia. Its Sustainable Technology Solutions (STS) business segment is based on process technology spanning ammonia/syngas/fertilizer solutions, chemicals/petrochemicals, clean refining and circular processes/circular economy.
stock market value: $7.91 billion ($59.36 per share)
Property: >1%
Average cost: n/a
Activist comment: Irenic Capital was founded in October 2021 by Adam Katz, former portfolio manager at Elliott Investment Management, and Andy Dodge, former investment partner at Indaba Capital Management. Irenic invests in public companies and works in collaboration with strong leaders. Until now, the company’s activism has focused on strategic activism, recommending spin-offs and sales of companies.
On December 19, 2024, Irenic announced that it plans to push KBR to separate its Sustainable Technology Solutions segment from its Government Solutions segment.
KBR is a Houston-based science, technology and engineering solutions company serving governments and businesses globally. The company is divided into two segments: Government Solutions (GS) and Sustainable Technology Solutions (STS). The GS segment operates as a government contractor providing defense, intelligence, space, aviation and other mission solutions for military and government agencies. The STS segment serves government and private sector customers with its broad technology portfolio focused on energy and sustainability across four main verticals: ammonia/syngas, chemicals/petrochemicals, clean refining and circular process solutions/circular economy. While both units have established a strong position in their respective end markets, they are fundamentally different. Government Solutions is a mature, low-margin business, while Sustainable Technology Solutions is a growing, high-margin business. The GS segment has seen revenue contraction since FY21 and adjusted earnings before interest, taxes, depreciation and amortization margins of approximately 10%. By contrast, STS has grown its revenue by an average of 16.7% annually since FY21 and has margins of about 20%.
In recent weeks, government contractors, including KBR, have seen a sector-wide downgrade in response to perceived risks associated with the incoming Trump administration. Investors have been speculating that the new Department of Government Efficiency (DOGE), with its mandate to cut federal spending, has already committed to Cutting $2 trillion from the federal budget could result in a significant decrease in the profitability of government contractors. As a result, between Election Day and the news that Irenic had gained a position in the company, KBR shares fell more than 18%. However, KBR may have been unduly punished for DOGE speculation. In reality, KBR appears to be 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’s business is international, primarily in United Kingdom, sheltered from the potential effects of DOGE. Looking at the remaining 75% of that segment in the US market, a detailed analysis reveals that only relatively small portions of KBR’s services are expected to face related estimated cost pressures. Although there is currently a lot of uncertainty, the threats to the GS segment seem, at this time, exaggerated. Additionally, the STS segment may be a beneficiary of the incoming administration’s plans. Under the Biden administration, there was a moratorium on export permits for LNG plants and several projects were put on hold. The Trump administration plans to reverse this, which could be a tailwind for KBR as the company is well positioned to win new and existing projects.
Perhaps attracted by KBR’s discounted valuation following the recent exogenous share price shock, Irenic has now entered the picture. Irenic has built up a position of more than 1% in the company and is urging management to separate its STS segment. These are fundamentally different businesses with different support needs, management requirements and end markets. Companies that are not owned together should be separated for several reasons: (i) each can attract the appropriate shareholder base and receive the appropriate multiple; (ii) each can dedicate management focus and compensation to be more aligned with specific business needs; and (iii) the separation can result in a reduction in corporate overhead costs, producing more agile and efficient entities. KBR currently trades at around 11.5 times enterprise value to trailing-12-month adjusted EBITDA. As for peer companies, GS’s typically trade in this range, but those closest to STS earn an average multiple of 14 to 15 times EBITDA. The separation of the two should reclassify the STS business as creating value for shareholders ahead of any cost savings from the separation. By separating the two businesses, there would be no need for many of the corporate costs the company currently incurs, which could result in a $50 million savings that would go directly to the bottom line. Finally, before any value creation, the company could buy back shares to create additional value for shareholders. While each value creation lever alone may not be incredibly compelling, the combination could result in a 50% increase in shareholder value.
Irenic is not the only shareholder who believes a separation makes sense; Many other shareholders share this opinion. To put it another way: keeping the two companies together makes no sense. A few years ago, it would have been fair to argue that a spinoff of STS was not feasible due to the size and youth of the unit. In 2021, the segment generated an operating loss of $30 million, and in subsequent years, management successfully made this argument by saying that the segment needed to be larger in order to be spun off. But STS now generates close to $400 million of EBITDA, and it’s time for management to follow suit. Irenic likes to work behind the scenes with management and use the power of persuasion to win the day. We expect the company to do so here until KBR’s announcement of a strategic review or the company’s nomination deadline on February 14, 2025, whichever comes first. If a satisfactory announcement is not made before February 14, we would expect Irenic to do something he has never had to do before: launch a proxy fight. However, given shareholder support for a separation and the fact that there is an empty board seat (General Lester L. Lyles recently announced will retire from the board of directors effective at the 2025 annual meeting) we do not expect it to come to that. If Irenic is given a board seat, it will likely go to an independent director with relevant industry experience rather than an Irenic director.
If KBR conducts a strategic review, we would be remiss if we did not mention a comparable and relevant situation. Elliott Funding Administration recently advocated for the separation of Honeywell into two companies, and Honeywell subsequently announced a strategic review of its businesses. Honeywell could be a potential strategic buyer of parts or all of KBR. Irenic co-founder Adam Katz was a former employee of Elliott Funding Administration and I’m sure he still knows people from 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.
