KBR welcomes Irenic as a new shareholder, and here's how the activist can contribute to increasing value.

Company: KBR Inc (KBR)

The company offers scientific, technology, and engineering solutions to governments and businesses worldwide. It operates through two segments: Government Solutions and Sustainable Technology Solutions. The Government Solutions segment provides full life-cycle support solutions to defense, intelligence, space, aviation, and other programs and missions for military and other government agencies in the United States, the United Kingdom, and Australia. The Sustainable Technology Solutions segment focuses on process technology that covers ammonia/syngas/fertilizers, chemical/petrochemicals, clean refining, and circular process/circular economy solutions.

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

Activist: Irenic Capital Management

Ownership: >1%

Average Cost: n/a

Adam Katz and Andy Dodge founded Irenic Capital in October 2021. The firm invests in public companies and collaborates with firm leadership. Irenic's activism has so far focused on strategic activism, recommending spinoffs and sales of businesses.

What's happening

Irenic declared on Dec. 19, 2024, that it intends to persuade KBR to separate its Sustainable Technology Solutions division from its Government Solutions division.

Behind the scenes

KBR is a Houston-based science, technology, and engineering solutions company that provides services to governments and companies worldwide. The company operates in two segments: Government Solutions (GS) and Sustainable Technology Solutions (STS). The GS segment provides solutions to defense, intelligence, space, aviation, and other missions for militaries and government agencies, while the STS segment serves both government and private sector clients with its extensive portfolio of energy and sustainability-focused technology in four primary verticals: ammonia/syngas, chemical/petrochemicals, clean refining, and circular process/circular economy solutions. While both units have established a strong foothold in their respective end markets, they are fundamentally different. Government Solutions is a low-margin mature business, while Sustainable Technology Solutions is a high-margin growing business. The GS segment has experienced revenue contraction since FY21 and has adjusted earnings before interest, taxes, depreciation, and amortization margins of about 10%. Conversely, STS has grown revenue by an average of 16.7% annually since FY21 and has margins of approximately 20%.

Government contractors, including KBR, have experienced sector-wide de-rating in recent weeks due to perceived risks associated with the incoming Trump administration. Investors have speculated that the new Department of Government Efficiency (DOGE), with its mandate to slash federal spending, could result in a material decline in government contractors' profitability. As a result, between Election Day and the report that Irenic had built a position in the company, shares of KBR fell more than 18%. However, KBR may have been unduly punished by 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 does account for 75% of KBR's revenue, it contributed less than half of its operating income in FY23. In addition, 25% of the GS business is international, primarily in the UK, sheltered from the potential effects of DOGE. Looking at the remaining 75% of that segment in the U.S. market, close analysis reveals that only relatively small portions of KBR's services are expected to face any related estimated cost pressures

Irenic has recently acquired a more than 1% stake in KBR and is pushing for the separation of its STS segment. The two businesses are fundamentally different with distinct support needs, management requirements, and end markets. Companies that don't belong together should be separated for several reasons, including attracting the appropriate shareholder base, aligning management focus and compensation with specific business needs, and reducing corporate overhead costs. KBR currently trades at around 11.5 times enterprise value to the last 12 months' adjusted EBITDA, while peer companies like GS typically trade in this range. However, those most like STS fetch an average multiple of 14-15 times EBITDA. Separating the two businesses could result in a $50 million savings and create additional shareholder value. The company could also buy back shares to increase shareholder value. The combination of these value creation levers could result in a 50% increase in shareholder value.

Irenic is not the only shareholder who believes a separation is necessary; many other shareholders share this view. In 2021, STS generated an operating loss of $30 million, but now generates close to $400 million of EBITDA. Management has successfully argued that the segment needs to be bigger to spin off. Irenic works behind the scenes with management to persuade them to make the right decision. The firm will likely be doing this up until either the announcement by KBR of a strategic review or the company's nomination deadline on Feb. 14, 2025, whichever comes first. If no satisfactory announcement is made by Feb. 14, Irenic may launch a proxy fight. However, given the shareholder support for a separation and the fact that there is an empty board seat, we do not expect it to come to that. If Irenic is given a seat on the board, it will likely be for an independent director with relevant industry experience as opposed to an Irenic principal.

If KBR decides to pursue a strategic review, it would be wise to bring up the recent situation involving Honeywell and Elliott Investment Management. Honeywell has recently announced a strategic review of its businesses, and Elliott Investment Management has advocated for the separation of Honeywell into two companies. Given that Irenic's co-founder, Adam Katz, was a former employee of Elliott Investment Management, it is likely that he still knows people there and could potentially facilitate a conversation between KBR and Elliott Investment Management.

Ken Squire is both 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.