Introduction
2023 marked a great bounce in Kyndryl shares with an 86.9% gain to $20.78/share but is still trading below its first day opening price of $28.41/share. In this post I will review what I believe were the key drivers that caused this bounce back in 2023. I still hold my shares at an $11.54/share price.
The pressure on money flow eased materially.
As outlined in my prior post, the shares of Kyndryl faced extraordinarily high selling pressure from IBM shareholders selling their spin shares and IBM dumping 20% of the float in the market on top of yearend tax loss selling.
After 2022, what sparked my interest to make an investment in this apparent dog?
Management presented what I thought was a logical thesis on why they had underperformed while owned by IBM.
Essentially, they laid out a case that they had been
locked into selling the IBM product suite therefore limiting their total addressable market.
They also laid out a case that the services business under IBM was the stepchild. The services business was mispricing their services in order for IBM to sell their software and hardware. Basically, positioned it as a loss leader.
Key investment questions to the thesis
Can Kyndryl get back to sales growth?
Can Kyndryl materially improve margins which are well below competitors?
The company laid out a plan known as the 3 A's which I have been spending the better part of 2023 vetting the viability of their plan. Below is a link to their last quarter's earnings presentation that outlines the strategy and provides a business update against the plan.
I want to point out my key take aways for the presentation that provides me encouragement.
Slide 15 - Outlines the 3A plan and the profit potential of the 3A's as background.
Page 23 - This slide shows that 40% (Wow) of their contracts were bid at zero gross margin under IBM. Let me repeat zero gross margin on $7-8 billion in revenue. Kyndryl plans to address this issue by repricing contracts at the end of their term (Typically 5-year term), remove low value-added content on renewal, and if unable to get a viable contract, then don't renew unprofitable revenue. Makes sense.
Slide 13 - Reflects they are really getting market margin rates on renewal at a level of 26% versus zero. It is unclear what revenue has been lost due to this initiative, but I don't know if it matters.
Slide 11 - Shows the progress they have made in 2023 against this plan. They are ahead on each part of the plan and raised their guidance on 2 of the three.
Slide 8 - Is the most encouraging update with only 1/3 of the low margin accounts renewed giving several more years of margin expansion by renewing 67% of low margin accounts at market rates.
Are actual results reflecting this improved margin performance?
So far, the answer appears to be yes. Below you will see a comparison from of pre-spin IBM financial results compared to TTM as of 9/23 under Kyndryl. You can see they are losing revenue down 13.1% but gross margins are up 24%. What is most important, the gross margin dollars is flowing thru the P&L with reduced loses at the Net Income and improved EBITDA. I still need to do work on why there was not change in normalized EBITDA.
Bottomline
The share price is up because the selling pressure from 2022 has abated and management appears to have made material progress in restoring profitability, but revenue growth still remains a challenge.
Next Post
In my next post I plan share my research to date on a litigation matter between BMC and IBM which may have a material adverse impact on Kyndryl. From there I will post my outlook for earning in 2024 and 2025.
Author: Rob McCourt
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