Irenik holds a position in the CBD. How an activist can increase shareholder value

Business: CBD provides science, technology and engineering solutions to governments and companies around the world. The company operates in two segments: Government Solutions and Sustainable Technology Solutions. Its Government Solutions (GS) business segment provides solutions to support the full lifecycle of 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 engineering covering ammonia/syngas/fertilizers, chemicals/petrochemicals, clean refining and cycle/circular economy solutions.

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

Ownership: >1%

Average cost: n/a

The activist’s comment: Irenic Capital was founded in October 2021 by Adam Katz, a former portfolio manager at Elliott Investment Management, and Andy Dodge, a former investment partner at Indaba Capital Management. Irenic invests in public companies and cooperates with the management of the firm. The firm’s activity so far has been focused on strategic activity, recommending spinoffs and business sales.

December 19, 2024 Irenic announced plans to force KBR to separate its sustainable technology solutions segment from its government solutions segment.

KBR is a Houston-based science, technology and engineering company that provides services to governments and companies around the world. 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 both government and private sector customers with its broad portfolio of energy and sustainability-oriented technologies in four primary verticals: ammonia/syngas, chemicals/petrochemicals, clean refining and circular processes/circular economy. Although both divisions have established themselves in their respective end markets, they are fundamentally different. Government Solutions is a mature business with low margins, while Sustainable Technology Solutions is a growing business with high margins. The GS segment has seen a decline in revenue since FY21, with EBITDA adjusted around 10%. In contrast, STS has grown revenue by an average of 16.7% annually since FY21 and has a margin of around 20%.

In recent weeks, government contractors, including KBR, have faced downgrades across the sector in response to perceived risks associated with the arrival of the Trump administration. Investors are speculating that the new Department of Government Efficiency (DOGE), which has a mandate to cut federal spending, is already committing cut 2 trillion from the federal budget can lead to a significant decrease in the profitability of government contractors. As a result, KBR stock fell more than 18% between Election Day and the announcement that Irenik had won a position in the company. However, KBR may have been unduly penalized by DOGE’s speculation. In fact, 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 GS’s business is international, mainly in the UK, protected from possible DOGE effects. Looking at the remaining 75% of this segment in the US market, a closer look shows that only a relatively small portion of KBR’s services are expected to face any relevant valuation cost pressure. ​​​​​​While much remains uncertain at this time, the threats to the GS segment seem overblown at the moment. Moreover, the STS segment could be a beneficiary of the future administration’s plans. Under the Biden administration, there was a moratorium on LNG plant export permits and several projects were put on hold. The Trump administration plans to change that, which could be a tailwind for KBR as the company is well-positioned to win new and existing projects.

Perhaps tempted by KBR’s reduced valuation following the recent exogenous stock price shock, Irenic has now entered the picture. Irenic has accumulated more than 1% in the company and is urging management to spin off its STS segment. These are fundamentally different businesses with different support needs, management requirements and end markets. Companies that are not owned by each other should be separated for several reasons: (i) each can attract an appropriate shareholder base and obtain an appropriate multiplier; (ii) each can tailor leadership and compensation to better suit the specific needs of the business; and (iii) separation can lead to reductions in corporate overheads, creating leaner and more efficient organizations. KBR currently trades at approximately 11.5 times enterprise value relative to trailing 12-month adjusted EBITDA. Looking at peers, GS companies typically trade in this range, but those most similar to STS fetch an average multiple of 14-15 times EBITDA. The separation of these two companies should re-evaluate the STS business that creates value for shareholders before the cost savings of the separation. Separating the two businesses would eliminate the need for the large corporate costs the company currently incurs, which could save $50 million in profits. Finally, before creating value, a company can buy back shares to create additional shareholder value. While each value driver may not be incredibly compelling on its own, the combination can lead to a 50% increase in shareholder value.

Irenic is not the only shareholder who thinks the spin-off makes sense; many other shareholders share this view. In other words, keeping the two companies together doesn’t make sense. A few years ago, it would have been fair to say that a separation of STS was impossible due to the size and youth of the unit. The segment posted an operating loss of $30 million in 2021, and management successfully made this argument in subsequent years, saying the segment needed to be bigger to spin off. But now STS is generating nearly $400 million in EBITDA, and it’s time for management. Irenic likes to work behind the scenes with management and use the power of persuasion to win. We expect the firm to do so here until KBR’s announcement of a strategic review or the company’s final spin-off deadline of February 14, 2025, whichever comes first. If no satisfactory announcement is made by February 14th, we expect Irenic to do something it has never done before – launch a proxy fight. However, given shareholder support for the spin-off and the fact that there is an empty seat on the board of directors (General Lester L. Lyles recently announced (he will step down from the board after the 2025 annual meeting) we don’t expect that to happen. If Irenic is given a seat on the board of directors, it will likely be for an independent director with relevant industry experience, rather than an Irenic director.

If KBR is indeed conducting a strategic review, we would be remiss if we did not mention a similar and relevant situation. Elliott Investment Management recently performed to split Honeywell into two companies, and Honeywell subsequently announced strategic review their enterprises. Honeywell could be a potential strategic buyer of parts or all of KBR. The co-founder of Irenic, 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 the 13D Activist Fund, a mutual fund that invests in a portfolio of 13D activist investments.