Revenue growth continues to decline at Kyndryl.....Driving the Alliance Initiative is critical to long term value creation.
Since the spin-off, revenues have declined by 13% as of 9/30/2023 on a TTM basis. The chart below shows revenue results by year. The trend is not positive and is most likely why the stock trades at a 9.5X of normalized EBITDA versus 17X for key competitors. Please note the company changed to a FY versus CY annual reporting period in 2023.
Management contends that the revenue decline is driven by 3 factors.
The spin-off workflow created a gap in backlog and signing of new contracts. Essentially the transaction distracted the organization.
Currency has been a head wind to results. Probably valid.
The biggest drag to revenue is the Account Initiative. Management is restructuring 40% of its pre spin revenue upon contract expiration that had zero gross margin as IBM was using services business as a loss leader in order to sell their other products. That is $7.8 billion in revenue that contributed no gross margin. Amazing! I will discuss in detail in another post. Management is repricing services and removing low margin job content from contracts to improve margins and will not keep an account that is not profitable. They are probably losing accounts, but management contends this has been limited so far and that most of the decline is from changes in scope. As a shareholder I support not taking on no margin business.
The primary spin-off strategy for Kyndryl was to address the low margin business but more importantly to increase the TAM so Kyndryl can return to revenue growth.
The premise was if Kyndryl is a standalone company they can now bid for business with positive margins but also offer their clients other services that customers we are seeking from competitors of IBM. For example, if the customer wants AWS or Google Cloud versus Red Hat, Kyndryl can now offer multiple choices to their clients. The Alliance Initiative is truly the strategy that will get the company back to revenue growth. Currently management is forecasting a return to growth in FY2026 or basically CY 2025.
So how is the company performing against the Alliance Initiative?
During last quarters conference call management reported that they are ahead of schedule. I have been trying to get a better sense of the progress since the quarterly update is limited in detail. To get a better idea I am tracking their press announcements to track activity against the Alliance objective.
I have sorted press releases announcements into Alliances (some have new products included in the release), signing of contracts, new products developed only by Kyndryl, and announcements related to skills/certifications. This is only intended to give a directional perspective to see if management is rebuilding a backlog and expanding their TAM. Below are two charts that give you a quarterly and annual cut of the press release data.
As you can see total activity is relatively the same year over year however announcements on partnerships/alliances have fallen off in 2023. That makes some sense since they have already signed with most major players. Going forward my focus will be looking for actual signings of contracts by leveraging these partnerships/alliances to rebuild the revenue backlog and return to revenue growth.
To give you a better perspective of the types of deals, below is a list of press release titles. As you review, you will see that their Alliance list is quite impressive.
Conclusion
The near-term upside to Kyndryl's results will be margin expansion from the Account Initiative at the expense of revenue growth however the long-term value upside for revenue growth from the Alliance Initiative. Bottomline, management has made progress in 2023 but needs to convert these deals into signed contracts and revenue.
My next post will discuss my take on the Account Initiative and outline my forecast to the profit upside.
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