Value Investors Club / JACOBS SOLUTIONS INC (J)

Description

Summary: (i) high quality market leader with long term structural tailwinds, (ii) trades at an absolute and relative discount as stock has been in “event purgatory” for more than a year while separating its last non-core business segment, (iii) process has taken longer than anticipated and created an information vacuum that will be resolved shortly, (iv) highly compelling risk/reward

History/Business:

#1 ranked engineering, design, consulting firm; S&P500, Fortune 500 company; large professional services company with 60K people (engineers, architects, data scientists, etc.) selling its expertise, IP and human capital, largely paid on per hour and/or cost-plus basis
High quality compounder, well-run, asset light, strong FCF generative business serving endmarkets that are both defensive/acyclical and benefit from current generational secular and regulatory tailwinds; operates with high visibility into multiyear revenue and earnings growth driven by record backlog and a diverse base of long term, low risk, higher margin contracts
Core Jacobs (PPS segment) is enjoying megatrends/tailwinds in water, infrastructure modernization, transportation, supply chain reshoring, clean energy/security; backed by “the three acts” (i.e., IIJA, IRA, and CHIPS) in concert, where planned outlays are still in early innings and drive growth and multiyear visibility; infrastructure spend alone is projected to ramp through ’27-’28 and sustain into the early 2030s; PPS’ Advanced Facilities business is another growth driver as the company has leading global market share in semiconductor (e.g., new fabs) and life science/pharma (e.g., GLP1) large new facility builds (both in process and announced/in pipeline)
Smart and aggressive management team has created a lot of value for shareholders (and themselves as material insider owners) via both operations and strategic moves; in recent years they divested all of their legacy energy exposure and fixed price E&C construction business, and as importantly, made successful acquisitions in its core go-forward business lines
The last of the non-core segments, Critical Mission Solutions (CMS), is a government services business operating across agencies under largely long term enterprise cost-plus contracts; CMS provides mission critical support services to key defense, space, energy, commercial and intelligence customers; key contracts/assets across NASA, DoE, MDA (Missile Defense) and Cyber/ISR
In May of last year, company announced its intention to spin off the CMS business; this was followed by reports of and then the company’s disclosure that they were thereafter approached by potential acquirors; in November, announced that the CMS business (plus Jacobs’ cyber business) would be separated via a RMT deal with private equity owned comp named Amentum (which itself was created out of AECOM’s government services segment, no public securities, has syndicated bank debt)
Jacobs effectively sold the CMS business at an estimated 12-13x EBITDA and at closing, Jacobs Remainco will receive $1B of cash + Jacobs shareholders will receive shares for 63% ownership of RMTCo (55% via effective spin + Jacobs Remainco will retain 8% of the shares to be monetized within a year of closing)
RMT transaction was a positive outcome as (i) 12-13x EBITDA was higher than buy and sell side expectations, (ii) was more tax efficient vs. an outright cash sale which would have driven material leakage due to the low basis of the CMS assets, and (iii) combined company will be one of the largest in the sector with immediate scale and synergy opportunities
On the flip side, the market initially responded negatively to the deal as a cleaner and quicker all cash sale was preferred (despite tax issue); instead got a highly complex deal/structure, very little information about the large merger partner Amentum, and initially inadequate disclosure made it difficult to easily calculate what EBITDA was being separated, for what multiple and therefore how much value per J share one would receive a year out; the company subsequently cleaned up some of the confusion but in the seven months since announcement there has been little/no additional information provided about Amentum in general, senior management (to be comprised of both CMS and Amentum executives) has not yet been able to meet with investors to explain the business and tell the story, and there has been no updated financial results for Amentum (other than qualitative commentary on conference calls and in the most recent deck which notes their “Strong momentum in backlog, revenue and profit growth”)
Going forward, Jacobs RemainCo will have only one segment as RMTCo gets all of the CMS segment and vast majority of small Divergent Solutions segment that houses the cyber business; this leaves core Jacobs (PPS) and its JV with PA Consulting
See May 2024 deck on IR website for additional detail and information on the company and the November 2023 decks for more information on the transaction

Thesis/Opportunity:

Jacobs Remainco pro forma: estimate EBITDA of $1.25-$1.35B, zero net debt, and ~$1B of targeted annual FCF
- Becomes best way to invest behind key abovementioned themes/megatrends via the global market leader; will be a clean, pure play “sleep at night” high quality compounder with downside protection from a defensive high FCF (~100% conversion) acyclical business and material upside as exposed to long term structural tailwinds supporting its organic growth targets for the next 3-5+ years
- In the year since the separation announcement, Remainco has reported accelerating top line growth, material margin expansion and a record backlog across endmarkets with particular strength in Advanced Facilities (Semis and Pharma), Water (pipeline has doubled) and Infrastructure (as IIJA dollars increasingly flowing into the market)
- RemainCo targets (i) high single-digit top line organic growth as it operates with multiyear visibility (driven by a record backlog, a strong pipeline, and a large/diverse/sticky customer base), and (ii) double-digit bottom line growth driven by accretive booked gross margin in backlog (higher value project mix/delivery model), normal operating leverage and a cost optimization plan that is projected to drive $140M of P&L savings (as management continues to rightsize the corporate overhead cost structure from what was a conglomerate to a smaller enterprise with simpler operations)
- Going forward, management has specifically de-emphasized M&A and stated that RemainCo pro forma FCF allocation will prioritize buybacks and shareholder return
- RemainCo pure play Jacobs and its thematic structural tailwinds should also attract large new pools of ESG and international capital to the market leader who many have not been able to invest in to date; this is because the CMS division does work for the US Department of Defense under certain contracts that caused Jacobs as a whole to be blacklisted and thus uninvestable by certain investors; these DoD contracts all go with CMS and the impediment to investing in Jacobs RemainCo thus goes away at closing

RMTCo pro forma: estimate EBITDA of $1.1-$1.2B, 3.6x net debt, and ~$600-$700M annual FCF
- Amentum’s information vacuum issue is about to be resolved as the Form 10 should be filed in short order followed by a management roadshow, comprehensive investor decks and complete financial information necessary to understand and model the business
- Based on prior disclosures and expert network calls, Amentum works with all major Federal customers with leading capabilities across digital engineering, intelligence analytics & operations, environmental remediation, and training & simulation; holds key contracts/assets across DoE, Air Force, Navy, INDOPACOM endmarkets
- CMS + Amentum combined will be one of largest companies in sector with a $50B backlog (3.7x revenue coverage), immediate scale advantages and growing installed base of recurring revenue and FCF supported by long-term diverse enterprise contracts (largest being <5% of EBITDA); management has indicated mid-high single digit organic growth targets and margin expansion opportunities beyond the initial $50-$70M of announced “highly visible” cost synergies target (represents only <50bps of combined revenue vs. 1-2% precedents)
- RMT transaction itself is a de-levering event for Amentum, the existing sponsors importantly are adding $235M of fresh equity to the transaction at closing and FCF will be initially directly to quickly de-lever to below 3x target

Conclusion:

Having a multitude of businesses at Jacobs historically overcomplicated the story for the market, was strategically unnecessary and the complex execution distracted management; the pending transaction solves these issues and more importantly, creates two attractive assets in a pure play market leader serving growing endmarkets and an advantaged scaled government services provider, each with discrete top and bottom line growth drivers
RemainCo comp EBITDA multiples: ACM 12.5x, WSP CN 14x, PSN 15x, TTEK 18.5x; M&A comp: RPS LN sold for 16x
RMTCo comp EBITDA multiples: SAIC 11.5x, KBR 12x, LDOS 12.5x, CACI 13.5x, PSN 15x, BAH 16x
Valuation/Targets:
- RemainCo at 14x forward EBITDA (19x earnings) = $148 per J share + RMTCo at 10x forward EBITDA (12x earnings) = $35 per J share, combined the package is worth $183 per J share, up ~30%; if Remainco trades closer to PSN (and still below TTEK to whom Jacobs water business is comparable if not better) and RMTCo trades closer to SAIC and KBR, the package is up ~50%
- At current $141/share, (i) if RMTCo trades at 9x forward EBITDA (10x earnings), are creating pure play Remainco at 10.5x forward EBITDA (14x earnings); conversely, if RemainCo trades 12.5x EBITDA, are creating RMTCo for 5.5x EBITDA and if Remainco trade at 13.5x EBITDA, are getting RMTCo for free

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Important Disclaimer:

The information contained herein (the “Information”) represents the views of the author as of the date submitted based on public information published or disseminated by the companies referenced below, including, but not limited to, through SEC filings, investor relations materials and public conference calls, or other third parties as of such date. Securities of the companies discussed herein have been and are currently portfolio holdings of the author or clients of the author’s firm. The Information does not constitute investment advice or a recommendation, and it is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or other asset or to participate in any trading or investment strategy. Nothing in this report shall be deemed to constitute tax, financial, or legal advice given by the author or the author’s firm to any party. Furthermore, not all relevant facts and information may have been considered in developing the Information and such Information is subject to change without notice. The author has no obligation (express or implied) to update any or all of the Information or to advise you of any changes to the Information; nor does the author make any express or implied warranties or representations as to the completeness or accuracy of the Information or accept responsibility for errors. You should not rely on the Information, in whole or in part, without conducting your independent verification as to its accuracy. The Information contains forward-looking statements, including observations about markets and industry and other trends as of the date hereof. Forward-looking statements may be identified by, among other things, the use of words such as "expects," "believes," “targets,” or "estimates," or the negatives of these terms, and similar expressions. Forward-looking statements reflect the views of the author as of such date with respect to possible future events. Actual results could differ materially from those in the forward-looking statements as a result of factors beyond the control of the author and you are cautioned not to place undue reliance on such statements. The Information may not be reproduced or disseminated in any manner without the express written consent of the author.

Catalyst

RMT / Spin of CMS business into Amentum

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			2024	2025
Price:	140.00	EPS	8.00	9.00
Shares Out. (in M):	127	P/E	17.5	15.5
Market Cap (in $M):	17,800	P/FCF	17.5	15.5
Net Debt (in $M):	2,000	EBIT	1,600	1,700
TEV (in $M):	19,800	TEV/EBIT	12.3	11.6