Business: Kerber Providing 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 unit provides full lifecycle support solutions for defense, intelligence, space, aviation 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 unit is based on process technologies and covers ammonia/syngas/fertilizers, chemicals/petrochemicals, clean refining and circular processes/circular economy solutions.

Stock market capitalization:$7.91B ($59.36 per share)

Government contractors, including KBR, have experienced industry-wide downgrades in recent weeks in response to risks associated with the incoming Trump administration. Investors have been speculating that the newly created Department of Government Efficiency (DOGE) has pledged to cut federal spending, Cut $2 trillion Withdrawals from the federal budget could result in a significant reduction in profitability for government contractors. As a result, KBR’s stock price fell more than 18% between Election Day and reports that Irenic had increased its holdings in the company. However, KBR may have been unduly punished for DOGE’s speculation. In fact, KBR appears to be more immune to these threats than the market currently believes. First, while the company’s GS business does account for 75% of KBR’s revenue, it contributed less than half of operating income in fiscal 2023. In addition, 25% of GS’s business is international, mainly in the UK, and is protected from the potential impact of DOGE. Looking at the remaining 75% of the segment in the US market, careful analysis shows that only a relatively small portion of KBR’s services is expected to face any associated estimated cost pressures. While there is a lot of uncertainty at the moment, the threats facing the GS segment appear to be overblown at the moment. Furthermore, the STS sector is likely to be a beneficiary of the incoming government’s schemes. Under the Biden administration, export licenses for LNG plants have been suspended and multiple projects have been put on hold. The Trump administration’s plans to reverse that could be a tailwind for KBR, as the company is well-positioned to win new and existing projects.

Perhaps tempted by KBR’s discounted valuation following the recent exogenous share price shock, Irenic has now joined in the fun. Irenic has amassed a stake of more than 1% in the company and has urged management to divest its STS unit. These are fundamentally different businesses, with different support needs, management requirements and end markets. Companies that are not part of the same company should be separated for the following reasons: (i) each can attract the appropriate shareholder base and command appropriate multiples; (ii) each can work on management focus and compensation to better align with specific Business needs; (iii) Separation can reduce corporate administrative costs and produce a leaner, more efficient entity. KBR currently trades at approximately 11.5 times trailing 12-month adjusted EBITDA enterprise value. Looking at peer companies, GS companies typically trade in this range, but those most like STS average 14-15x EBITDA. Separating the two should reassess the value the STS business creates for shareholders before considering any cost savings from a spin-off. By separating the two businesses, the company will no longer need to bear the significant corporate costs it currently carries, potentially saving $50 million that can be directed directly to the bottom line. Finally, before any value is created, the company can buy back shares to create additional shareholder value. While each value creation lever may not be incredibly attractive on its own, the combination could result in a 50% increase in shareholder value.

Irenik isn’t the only shareholder who thinks a spinoff makes sense. Many other shareholders share the same view. In other words: It doesn’t make sense for the two companies to merge. A few years ago, it’s fair to say that spinning off STS wasn’t feasible due to the size and youth of the division. In 2021, the unit posted an operating loss of $30 million, and in the years since, management has successfully made the argument that the unit needed to grow in size before it could be spun off. But with STS now generating nearly $400 million in EBITDA, it’s time for management to take action. Irenik enjoys working behind the scenes with management and using the power of persuasion to win. We expect the company will do so until KBR announces the strategic review or the company nomination deadline of February 14, 2025, whichever comes first. If no satisfactory announcement is made by February 14, we expect Irenic to do something it has never done before – launch a proxy fight. However, given the fact that shareholders support the separation and the board seat is vacant (General Lester L. Lyles recently announced He will retire from the Board after the 2025 Annual Meeting) We do not expect this to be the case. If Irenic were to gain a board seat, it would likely be to an independent director with relevant industry experience, rather than to the head of Irenic.

If KBR does conduct a strategic review, we would be remiss if we did not mention a similar and relevant situation. Elliot Investment Management Recently advocated Honeywell split into two companies, Honeywell later announced strategic review its business. Honeywell could become a potential strategic acquirer of part or all of KBR. Adam Katz, co-founder of Irenic, is a former employee of Elliott Investment Management and I believe 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 activist 13D portfolios.