Starboard aims to unlock the value of Fluor’s investment in nuclear tech company NuScale

Company: Fluor Corp (FLR)

a job: Fluor It is a holding company that provides engineering, procurement, construction, manufacturing, modularization and project management services. The company’s segments include Energy Solutions, Urban Solutions and Mission Solutions. The Energy Solutions segment provides EPC services to traditional oil and gas markets, including production, fuels, chemicals, LNG and power markets. This sector serves these industries with comprehensive project life cycle services. The Urban Solutions segment provides EPC and project management services to the advanced technology, manufacturing, life sciences, mining and metals, infrastructure industries and professional staffing services. The Mission Solutions segment provides cutting-edge technology solutions to the United States and other governments. These include, among others, the Department of Energy, the Department of Defense, the Federal Emergency Management Agency and intelligence agencies. This segment also provides services to commercial nuclear customers.

Stock market value: $7.89 billion ($48.79 per share)

Activist: Starboard value

ownership: Starboard value

Average cost: unavailable

Activist’s comment: Starboard is a highly successful activist investor with extensive experience helping companies focus on operational efficiency and margin improvement. They are known for their excellent diligence and for managing many of the most successful campaigns. Starboard initiated active campaigns in 18 prior industry stocks and its average return on these positions is 50.55% versus an average of 11.73% for the Russell 2000 over the same time periods. Starboard has taken a total of 162 previous activist campaigns in its history and generated an average return of 21.13% versus 14.24% for the Russell 2000 campaigns during the same period.

What is happening

On October 21, Starboard announced its acquisition of a roughly 5% stake in Fluor and stated its intention to unlock value from the company’s approximately 39% stake. NewScale Powerwhich represents more than 60% of the company’s market value, including through a potential spin-off.

backstage

Fluor provides integrated engineering, procurement, construction and project management services, covering a variety of end markets. Historically, the EPCM market has been a highly competitive landscape that has led to significant risk taking, where growth has often been prioritized over discipline and profitability. For Fluor, as well as much of the industry, this has led to management significantly increasing the backlog of high-risk lump sums and guaranteed minimum contracts, resulting in execution risk, thin profit margins and cost overruns. Ultimately, this industry-wide shift caused many companies to scale back construction efforts or even enter bankruptcy, and Fluor was no exception, with the company’s stock price falling below $4 in March 2020.

However, this began to change when the company appointed David Constable as CEO at the beginning of 2021. Under his leadership, Fluor immediately focused on low-risk recoverable projects, increasing from 45% of backlog to 80%, while exposure to loss-making legacy projects decreased from US$1.8 billion to US$558 million today, meaningfully reducing risk.

Additionally, although largely associated with legacy energy projects, the company has tapped into faster-growing markets within its Urban Solutions segment, which now represents 73% of its backlog compared to 37% in fiscal 2021. As a result, even with this de-risking effort, Fluor was still able to maintain a steady backlog and deliver significant EBIT growth and depreciation and amortization, a CAGR of 14% from FY2021 to FY2024, with analysts expecting a CAGR of 9% from FY2024 to FY2028.

With many major construction companies and EPCM companies exiting the market, Fluor’s operational transformation has allowed it to come out the other side of the turmoil to the top, where it now operates in a duopoly of global EPCM players with Bechtel, while the construction market has grown rapidly, to over $918 billion.

As a result of this successful operational reform, the market currently values ​​Fluor at 8.9x enterprise value through calendar year 2027 EBITDA estimates, between EPCM (13x) and legacy construction peers (6x). So, Fluor appears to be a great company with a great management team operating in a duopoly in a growing industry that’s somewhat valued at an enterprise value of $6.7 billion. However, Fluor also owns a 39% stake in NuScale, a publicly traded small modular nuclear reactor company.

Fluor has invested in NuScale more than a decade ago, and its early $30 million investment played a pivotal role in NuScale becoming the first SMR company listed in the United States, and the only company of its kind to receive U.S. Nuclear Reactor Commission design approval.

As global energy demand continues to rise, particularly alongside the data center boom, nuclear power generation will be vital, and small and medium reactors will play an essential role in providing the energy to meet this growth. As a result, Fluor’s investment in NuScale was highly profitable – valued at approximately US$4.3 billion ($3.4 billion after taxes). This represents more than half of Fluor’s current enterprise value.

If you removed NuScale’s share of Fluor’s valuation, Fluor’s enterprise value would fall to $3.3 billion, which would mean a very low discount of just 4.6x, with peers trading at 6-13x.

Starboard has taken a roughly 5% stake in Fluor and is urging management to unlock value from its holdings in NuScale. Starboard believes Fluor has multiple paths to monetize its remaining stake in NuScale. These options involve simply selling its position through open market sales, exchange offer, or mandatory redeemable notes, with the proceeds potentially funding a significant share repurchase, which could result in significant accretion to Fluor’s earnings per share, especially given its currently low valuation.

Alternatively, Starboard has proposed a tax-free spin-off of Fluor’s NuScale position, which could result in a similar reclassification of the underlying business while providing Fluor shareholders with the option of retaining their exposure to NuScale’s long-term potential.

Thus, assuming Fluor maintains its 8.9x EBITDA multiple, which could still be improved given its discount to its EPCM peers, the rerating that could come from this separation could result in more than 200% upside.

Starboard is a very experienced activist who also has a history in the industry. In June 2019, Starboard engaged another construction player, AECOM, and over the ensuing multi-year engagement, AECOM refreshed its board, appointed a new CEO, exited self-performing construction, and divested of management services. This became one of Starboard’s most profitable contracts in its history, returning 147% on 3D packaging versus 26% for the Russell 2000.

But more importantly, they met David Constable for the first time. Constable is Fluor’s CEO and until February served as its CEO. Therefore, we expect that the mutual respect between Starboard and Constable will lead to a friendly, constructive and beneficial relationship for shareholders.

Ken Squire is founder and president of 13D Monitor, an institutional research service on shareholder activism, and founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist investments.