Irenić takes a position at KBR. How an activist can improve shareholder value

Job: CBR provides science, technology 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 life-cycle support solutions for defense, intelligence, space, aerospace 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 is based on process technology that includes solutions for ammonia/syngas/fertilizers, chemicals/petrochemicals, clean refineries and circular processes/circular economy.

Stock market value: USD 7.91 billion ($59.36 per share)

In recent weeks, government contractors, including KBR, have experienced sector-wide downgrades in response to perceived risks associated with the incoming Trump administration. Investors speculated that the new Department of Government Efficiency (DOGE), with its mandate to cut federal spending, had already committed to cut $2 trillion from the federal budget, could result in a significant drop in the profitability of government contractors. As a result, between Election Day and reports that Irenic had built a position in the company, KBR shares fell more than 18%. However, KBR may have been unduly penalized by DOGE speculation. In reality, KBR appears to be more insulated from these threats than the market currently perceives. First, although the company’s GS business accounts for 75% of KBR’s revenue, it contributed less than half of its operating income in FY23. In addition, 25% of GS’s business is international, primarily in the UK, protected from the potential effects of DOGE. Looking at the remaining 75% of that segment in the US market, close analysis reveals that only relatively small portions of KBR’s services are expected to face the estimated cost pressures. While much is currently uncertain, the threats to the GS segment seem overblown at this point. Moreover, the STS segment may benefit from the plans of the incoming administration. Under the Biden administration, there was a moratorium on export permits for LNG facilities and several projects were put on hold. The Trump administration plans to reverse that, 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 scene. Irenic has accumulated a position of more than 1% in the company and is urging management to spin off its STS segment. These are fundamentally different companies with different support needs, management requirements and end markets. Companies that do not belong together should be separated for several reasons: (i) each can attract a suitable shareholder base and obtain a suitable multiple; (ii) each can focus on management and compensation to be more aligned with specific business needs; and (iii) the separation may result in a reduction in the company’s overhead costs, creating smaller and more efficient entities. KBR currently trades at around 11.5 times enterprise value relative to trailing 12-month adjusted EBITDA. Looking at comparable companies, those from GS tend to trade in this range, but those most similar to STS achieve an average multiple of 14-15 times EBITDA. Separating the two should reassess STS’s shareholder value-creating business before any cost savings from the separation. Separating the two businesses would eliminate the need for many of the corporate expenses the company currently incurs, which could result in $50 million in savings going right to the bottom line. Finally, before any value creation, the company could buy back shares to create additional shareholder value. While each lever of value creation on its own may not be incredibly compelling, the combination could result in a 50% increase in shareholder value.

Irenić is not the only shareholder who thinks that the separation makes sense; many other shareholders share this opinion. In other words: keeping two companies together makes no sense. A few years ago, it would be fair to argue that splitting STS 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 the years since, management has successfully made this argument that the segment needs to be bigger in order to stand out. But STS is now generating close to $400 million in EBITDA and it’s time for management to move on. Irenic likes to work behind the scenes with management and use the power of persuasion to win. We expect the company to do so here until the announcement of a strategic review by KBR or the company’s nomination deadline of February 14, 2025, whichever comes first. If a satisfactory announcement is not made by February 14th, we would expect Irenic to do something he has never had to do before – start a proxy fight. However, given shareholder support for the spin-off and the fact that there is a vacant board seat (General Lester L. Lyles recently published he will retire from the board after the annual assembly in 2025) we do not expect that to happen. If Irenic gets a seat on the board, it will likely be for an independent director with relevant industry experience, as opposed to an Irenic director.

If KBR is conducting a strategic review, we would be remiss if we did not mention a similar and relevant situation. Elliott Investment Management has recently advocated to separate Honeywell into two companies, and Honeywell subsequently announced strategic review of their jobs. Honeywell could 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 activist 13D investments.