Irenic takes a position at KBR. How an activist can increase shareholder value

Business: CBR provides science, technology and engineering solutions to governments and companies worldwide. The company operates in two segments: Government Solutions and Sustainable Technology Solutions. 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 US, UK and Australia. Its Sustainable Technology Solutions (STS) business segment is connected with process technology covering ammonia/syngas/fertilizers, chemical/petrochemical, clean refining and circular process/circular economy solutions.

Stock Value: $7.91B ($59.36 per share)

In recent weeks, government contractors, including KBR, have faced sector-wide downgrades in response to perceived risks associated with the incoming Trump administration. Investors over the new Department of Government Efficiency (DOGE) with a mandate to cut federal spending 2 trillion dollars cut from the federal budget, may result in a significant decrease in the profitability of government contractors. As a result, KBR shares fell more than 18% between Election Day and the report of Irenik’s position at the company. However, KBR may have been unduly penalized by DOGE assumptions. 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 generated less than half of its operating income in FY23. In addition, 25% of GS’s business is international, primarily in the UK, which has been shielded from the potential effects of DOGE. Looking at the remaining 75% of that segment in the US market, close analysis shows that only a relatively small portion of KBR services are expected to experience any associated estimated cost pressures. While much is uncertain at the moment, the threats to the GS segment seem overblown at this point. Additionally, the STS segment could benefit from the incoming administration’s plans. During the Biden administration, a moratorium was placed on export permits for LNG plants and several projects were shelved. The Trump administration plans to repeal it, which could be a tailwind for KBR as the company is well-positioned to win new and existing projects.

Perhaps lured by KBR’s discounted valuation after the recent exogenous share price shock, Irenic has now entered the picture. Irenic has accumulated more than 1% position in the company and urges the management to separate the STS segment. These are fundamentally different businesses with different support needs, management requirements and end markets. Unrelated companies should be separated for several reasons: (i) each can attract an appropriate shareholder base and be rewarded with an appropriate majority; (ii) each may allocate management attention and compensation to better align with specific business needs; and (iii) decoupling can result in reduced corporate overheads, leading to leaner and more efficient enterprises. KBR currently trades at an enterprise value of approximately 11.5 times trailing 12-month adjusted EBITDA. Looking at peers, GS companies typically trade in this range, but most companies like STS come in at 14-15 times EBITDA. Separating the two would require revaluing the STS business, which creates value for shareholders, before any cost savings from the separation. By separating the two entities, the company will no longer need to incur many of the corporate costs it currently incurs, which could result in savings of $50 million. Finally, before creating any value, the company can buy back shares to create additional shareholder value. While each value-creating arm is not incredibly attractive on its own, the combination can result in a 50% increase in shareholder value.

Irenic is not the only shareholder who thinks the separation makes sense; many other shareholders share this view. In other words: It makes no sense to keep two companies together. It would be fair to argue that a few years ago the division of STS was impossible due to the size and youth of the division. In 2021, the segment posted an operating loss of $30 million, and in subsequent years, management successfully made the argument that the segment needed to be bigger to be spun off. But STS is now delivering close to $400 million in EBITDA, and it’s time for management to step up. Irenic likes to work behind the scenes with management and use her powers of persuasion to win the day. We expect the firm to do so by the announcement of the strategic review by KBR or the company’s nomination deadline of February 14, 2025, whichever comes first. If no satisfactory announcement is made by February 14th, we would expect Irenik to do something he has never done before – start a proxy fight. However, given shareholder support for the separation and the vacant board seat (General Lester L. Lyles) announced recently will resign from the board effective after the 2025 annual meeting) we do not expect that to happen. If Irenic is given a seat on the board, it will likely be an independent director with relevant industry experience, unlike an Irenic director.

If KBR conducts strategic research, we would be remiss if we did not mention a similar and relevant situation. Elliott Investment Management recently advocated For the separation of Honeywell into two companies and later announced Honeywell strategic vision enterprises. Honeywell could be a potential strategic buyer of parts or all of KBR. Irenik’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 shareholder activism research service, and the founder and portfolio manager of 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.