KBR - a spinoff play

Some current metrics:

Current P/E: <11

EV/EBITDA: 7

EBITDA Margin: 12.4% (adjusted)

Price/Sales: 0.59

Price/FCF: 9.2

Backlog and options of $23.2B while doing annual revenues of $7.8B.

KBR is a service and engineering company. A brief summary of their two primary segments:

1. Mission Technology Solutions (MTS). KBR is a major defense contractor for the US DoD (DoW?). The work they do includes systems engineering, IT, procurement as a service and a lot more that's too minute to list. Other customers included civilian US Govt agencies (KBR is currently in a huge contract with NASA to support the Artemis program) and foreign governments/militaries, mainly UK and AUS. This business is consistent but has low net margins in the mid-single digits. 2. Sustainable Technology Solutions (STS). This is the attractive part. KBR holds a handful of patents related to hydrocarbons and licenses them out. They're big in ammonia, chemicals, clean refining, plastics (recycling), and sustainable aviation fuel. KBR's ammonia tech is used in over 50% of the world's ammonia plants. For example, Shell uses their tech to produce ammonia from natty gas. This licensing is relatively high margin and provides steady cash flows for the typical 10-20 years contract term. The other side of their STS business provides engineering services, project management, procurement, consulting, etc for energy producers. For example, they recently won a contract for project management and technical services to expand the Zallaf South Refinery in Libya. STS is a growing business that boosts double digit margins.

The catalyst will be the spin-off at the end of the year. KBR will spin-off its MTS business (SpinCo) while the “new” KBR will retain the STS business.

STS has always been a deeply undervalued business that has been overshadowed by the low-margin government business. STS has TTM revenue of $2.2B , $479mm in adjusted EBITDA (22% EBITDA margin), and a $4B backlog. Valuation is difficult as there are no 1:1 peers. Perhaps the closest comps are parts of Worley Limited, Fluor, Linde, AMTM – those firms trade at multiples a few turns higher than KBR now does. Personally, I believe STS would likely warrant a multiple at least in the mid-teens if not higher. That’s based on the fact that STS has pulled off 15% CAGR for the past few years; management suggests that growth is still strong and has also forecasted EBITDA margins to remain above 20%.

For the SpinCo I see upside too, just not a lot. For comparison, SAIC which mainly provides govt IT services and has a very similar balance sheet currents trades at 12x P/E. Leidos, another competitor trades at 14x P/E. Given that the current KBR trades at just under 11x P/E, there is some upside for a standalone MTS a little bit above where SAIC stands. Tailwinds I see for MTS are increased defense spending and the golden dome missile defense project. The former is possible given the global environment however I’m more skeptical of the latter. Still, recent conflicts in Europe and the Middle East have shown the need for air and missile defense (IAMD) systems. KBR has a hand in supporting existing platforms like Patriots, C-RAM, and THAAD as well as the development of new IAMD systems. Possible headwinds I see are government austerity and costs inflation affecting margins on fixed priced contracts.

For some napkin math with conservative numbers, if the new KBR with STS gets a 13 EV/EBITDA, it would have an EV of ~6.2B.

And if we assume SpinCo (MTS) gets a 7 EV/EBITDA it would have an EV of ~$4B.

For reference, the full KBR now has an EV of ~7B

Downsides and Risks I see:

- Debt level is a little high. $2.5 billion in LTD against $500 million cash on hand; Fitch rates it at BB+

- Might not see much price movement until spin-off terms are released or even until after finalized.

-STS has exposure to dangerous parts of the world -- various ongoing projects in Qatar, Kuwait, KSA, Iraq (I think one of their offices got blown up by a drone).

tldr; KBR trades at record low valuations while housing an energy division that is growing in the double digits. I see 30% upside once KBR completes its spinoff as

I am in with 124 shares at a cost basis of $36.88. I think the risk-reward here is attractive here.

Not much discussion on KBR online so thoughts?