Please ensure Javascript is enabled for purposes of website accessibility

5 Things Investors Must Know About IBM's Kyndryl Spin-Off

By Leo Sun – Oct 5, 2021 at 8:00AM

Key Points

  • IBM will spin off its managed infrastructure services unit as Kyndryl by the end of the year.
  • Kyndryl’s standalone financials look dismal.
  • Investors should follow IBM's lead and sell their new shares of Kyndryl once the spin-off completes.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Big Blue will drop a lot of dead weight by the end of 2021.

Last October, IBM (IBM -0.85%) announced it would spin off the managed infrastructure services division of its Global Technology Services business by the end of 2021. In April, IBM named the upcoming spin-off Kyndryl but didn't disclose any additional details at the time.

In late September, Kyndryl filed an SEC report that finally revealed its exact growth rates. Let's review the five key highlights from that filing, and see if they make Kyndryl a worthwhile investment.

An IT services professional checks a server.

Image source: Getty Images.

1. Expect more revenue declines

Kyndryl's revenue declined 7% to $20.3 billion in 2019 and fell 5% to $19.4 billion in 2020. It ended 2020 with approximately 4,400 customers, down from 4,600 at the end of 2019.

It attributed its declines last year to a "reduction in client volumes within industries heavily impacted by the global pandemic." In the first half of 2021, Kyndryl's revenue dipped another half percent year over year to $9.52 billion.

By comparison, Kyndryl's larger IT services competitor Accenture (ACN -2.46%) grew its revenue 5% in fiscal 2019, 3% in 2020, and 14% to $50.5 billion in 2021. That jarring comparison suggests that Kyndryl's declines weren't entirely caused by macro headwinds. IBM's focus on cutting Kyndryl's costs likely dulled its competitive edge, as well as its ability to keep pace with nimbler rivals like Accenture.

2. Expect lower gross margins

Kyndryl's gross margin expanded from 11.7% in 2018 to 12.8% in 2019, but declined to 11.4% in 2020 and contracted another 40 basis points year over year to 10.3% in the first half of 2021.

By comparison, Accenture booked a gross margin of 32.4% in fiscal 2021, compared to 31.5% in 2020 and 30.8% in 2019. Accenture's higher gross margins and superior growth rates clearly suggest it's pulling customers away from Kyndryl and other IT services companies.

3. Don't expect any profits

Kyndryl is also deeply unprofitable. It racked up net losses of $990 million in 2018, $943 million in 2019, and $2.01 billion in 2020, which included $918 million in pre-tax charges for layoffs and other "workforce rebalancing" measures. In the first half of 2021, it booked a net loss of $887 million, which included $232 million in pre-tax spin-off charges.

Meanwhile, Accenture has stayed consistently profitable, and its adjusted net income (which excludes investment-related gains) increased 17% to $5.76 billion in fiscal 2021.

Kyndryl generated a negative free cash flow (FCF) of $324 million in 2020, as well as a negative FCF of $786 million (including about $0.5 billion in restructuring and spin-off-related charges) in the first half of 2021. But excluding IBM's marketing and sales integrations, Kyndryl generated an adjusted positive FCF of $0.7 billion in 2020, which the company claims is a "more representative view" of its future.

4. Expect lower dividends

Kyndryl's profitability and FCF might improve after it moves past all of its restructuring and spin-off charges, but it still probably won't generate much excess cash for buybacks or dividends.

After the spin-off concludes, IBM claims the "initial combined dividend" of the two companies will be "no less than IBM's pre-spin dividend per share." However, the "payment of any dividends in the future, and the timing and amount thereof, is within the discretion of the Board."

That statement suggests IBM's current forward yield of 4.6% will be significantly reduced in the future. The "new" IBM will likely conserve its cash for fresh investments in the hybrid cloud and AI markets, while Kyndryl probably won't pay higher dividends until its losses narrow and its FCF growth stabilizes.

5. IBM's investors will get Kyndryl shares

It's easy to see why IBM wants to boot Kyndryl's operations from its balance sheet, but it isn't clear why investors would want to own a piece of this new company.

IBM's current investors won't have a choice. After the spin-off concludes, IBM's shareholders will receive new shares equivalent to 80.1% of Kyndryl, while IBM will retain an equity stake of less than 19.9% and reclassify the business segment as a discontinued operation.

IBM plans to exchange all of its remaining shares of Kyndryl for debt within the following 12 months, which doesn't inspire much confidence in the IT spin-off's future.

Buy better IT services stocks instead

I don't own any shares of IBM. But if I did, I'd sell my new shares of Kyndryl right away. IBM is eager to divest Kyndryl because it's a dead weight on its top and bottom lines.

If Kyndryl generated more cash for buybacks or dividends, it could be a worthwhile investment -- but that isn't the case. In short, I can't see any compelling reasons to buy Kyndryl. It's a smart move for IBM, but it's a misleading deal for investors who believe Kyndryl will thrive on its own.

Leo Sun owns shares of Accenture. The Motley Fool owns shares of and recommends Accenture. The Motley Fool has a disclosure policy.

Stocks Mentioned

International Business Machines Stock Quote
International Business Machines
IBM
$147.41 (-0.85%) $-1.26
Accenture Plc Stock Quote
Accenture Plc
ACN
$292.74 (-2.46%) $-7.39

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.