Irenic takes a position at KBR. How the activist may improve shareholder value

Enterprise: KBR gives scientific, know-how and engineering options to governments and firms all over the world. The corporate operates via two segments: Authorities Options and Sustainable Know-how Options. Its Authorities Options (GS) enterprise phase gives full life-cycle assist options to protection, intelligence, area, aviation and different packages and missions for navy and different authorities businesses in the USA, the UK and Australia. Its Sustainable Know-how Options (STS) enterprise phase is anchored by course of know-how that spans ammonia/syngas/fertilizers, chemical/petrochemicals, clear refining and round course of/round financial system options.

Inventory Market Worth: $7.91B ($59.36 per share)

Possession: >1%

Common Price: n/a

Activist Commentary: Irenic Capital was based in October 2021 by Adam Katz, a former portfolio supervisor at Elliott Funding Administration, and Andy Dodge, a former funding associate at Indaba Capital Administration. Irenic invests in public firms and works collaboratively with agency management. The agency’s activism has to this point targeted on strategic activism, recommending spinoffs and gross sales of companies.

On Dec. 19, 2024, Irenic introduced that it plans to push KBR to separate its Sustainable Know-how Options phase from its Authorities Options phase.

KBR is a Houston-based science, know-how and engineering options firm that gives providers to governments and firms globally. The corporate is split into two segments: Authorities Options (GS) and Sustainable Know-how Options (STS). The GS phase operates as a authorities contractor offering options to protection, intelligence, area, aviation and different missions for militaries and authorities businesses. The STS phase serves each authorities and personal sector shoppers with its in depth portfolio of power and sustainability-focused know-how in 4 major verticals: ammonia/syngas, chemical/petrochemicals, clear refining and round course of/round financial system options. Whereas each items have established a robust foothold of their respective finish markets, they’re essentially completely different. Authorities Options is a low-margin mature enterprise, whereas Sustainable Know-how Options is a high-margin rising enterprise. The GS phase has skilled income contraction since FY21 and has adjusted earnings earlier than curiosity, taxes, depreciation and amortization margins of about 10%. Conversely, STS has grown income by a mean of 16.7% yearly since FY21 and has margins of roughly 20%.

In latest weeks, authorities contractors, together with KBR, have skilled sector-wide de-rating in response to perceived dangers related to the incoming Trump administration. Traders have been speculating that the brand new Division of Authorities Effectivity (DOGE), with its mandate to slash federal spending, already pledging to trim $2 trillion from the federal price range, may end in a cloth decline in authorities contractors’ profitability. In consequence, between Election Day and the report that Irenic had constructed a place within the firm, shares of KBR fell greater than 18%. Nonetheless, KBR might have been unduly punished by DOGE hypothesis. In actuality, KBR seems to be extra insulated from these threats than the market at the moment perceives. First, whereas the corporate’s GS enterprise does account for 75% of KBR’s income, it contributed lower than half of its working earnings in FY23. As well as, 25% of the GS enterprise is worldwide, primarily within the UK, sheltered from the potential results of DOGE. Trying on the remaining 75% of that phase within the U.S. market, shut evaluation reveals that solely comparatively small parts of KBR’s providers are anticipated to face any associated estimated price pressures. Whereas a lot is at the moment unsure, the threats to the GS phase appear, at this second, overblown. Furthermore, the STS phase could also be a beneficiary of the incoming administration’s plans. Below the Biden administration, there was a moratorium on export permits for LNG vegetation and several other tasks had been placed on maintain. The Trump administration plans to reverse this, which might be a tailwind for KBR as the corporate is well-positioned to win new and present tasks.

Maybe enticed by KBR’s discounted valuation following the latest exogenous share value shock, Irenic has now entered the image. Irenic has gathered a place of greater than 1% within the firm and is urging administration to separate its STS phase. These are essentially completely different companies with distinct assist wants, administration necessities and finish markets. Corporations that do not belong collectively needs to be separated for a number of causes: (i) every can appeal to the suitable shareholder base and be awarded the right a number of; (ii) every can dedicate administration focus and compensation to be extra aligned with particular enterprise wants; and (iii) separation can lead to a discount of company overhead prices, producing leaner and extra environment friendly entities. KBR at the moment trades round 11.5 occasions enterprise worth to the final 12 months’ adjusted EBITDA. peer firms, these of GS usually commerce on this vary, however these most like STS fetch a mean a number of of 14-15 occasions EBITDA. Separating the 2 ought to re-rate the STS enterprise creating worth for shareholders earlier than any price financial savings from the separation. By separating the 2 companies, there can be no want for lots of the company prices the corporate presently incurs, which may end in a $50 million financial savings that goes proper to the underside line. Lastly, forward of any worth creation, the corporate may purchase again shares to create further shareholder worth. Whereas every worth creation lever by itself may not be extremely compelling, the mix may end in a 50% improve in shareholder worth.

Irenic just isn’t the one shareholder who thinks a separation is sensible; many different shareholders share this view. To place it otherwise: Conserving the 2 firms collectively is not sensible. A number of years in the past, it could’ve been truthful to argue {that a} spin-off of STS wasn’t possible due to the unit’s dimension and youth. In 2021, the phase delivered an working lack of $30 million and within the years after, administration efficiently made this argument saying the phase wanted to be greater to spin off. However STS now generates near $400 million of EBITDA, and it’s time for administration to stroll the stroll. Irenic likes to work behind the scenes with administration and use the ability of persuasion to win the day. We anticipate the agency shall be doing that right here proper as much as both the announcement by KBR of a strategic evaluation or the corporate’s nomination deadline on Feb. 14, 2025, whichever comes first. If no passable announcement is made by Feb. 14, we might anticipate Irenic to do one thing that it has by no means needed to do earlier than – launch a proxy battle. Nonetheless, given the shareholder assist for a separation and the truth that there’s an empty board seat (Basic Lester L. Lyles just lately introduced he’ll retire from the board efficient after the 2025 annual assembly) we don’t anticipate it can come to that. If Irenic is given a seat on the board, it can possible be for an impartial director with related business expertise versus an Irenic principal.

If KBR does pursue a strategic evaluation, we might be remiss if we didn’t point out an analogous and related scenario. Elliott Funding Administration has just lately advocated for the separation of Honeywell into two firms, and Honeywell subsequently introduced a strategic evaluation of its companies. Honeywell might be a possible strategic acquirer of components or everything of KBR. Irenic’s co-founder, Adam Katz, was a former worker of Elliott Funding Administration, and I’m certain he nonetheless is aware of individuals over there.

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