Kyndryl Holdings, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

Kyndryl Holdings, Inc. is a leading global IT infrastructure services provider, specializing in designing, building, managing and modernizing complex IT environments.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Kyndryl operates as a spin-off from IBM’s managed infrastructure services business, and its goal is to modernize and manage customer IT systems. The business is quite complex, as it involves offering a range of services including consulting, implementation, and maintenance for IT infrastructure, including networking, servers, and cloud platforms.

  • Revenue Distribution: The company has three major business segments - United States, Japan, and Principal Markets, which are further broken down by geographic location and industry focus.
    • United States: Accounts for the largest portion of revenues, providing IT services across various sectors.
    • Japan: A significant market with a strong presence in the financial services and technology sectors.
    • Principal Markets: Represents operations across multiple geographical regions including Australia, New Zealand, Canada, Europe and India.
  • Importantly, revenue is derived from technology, cloud, communications, industrial, health and financial clients.
    • The company has a diverse set of clients, but is looking to increase its presence with strategic clients in the financial and telecommunications sectors, as well as expand into new regions.
  • Industry Trends:
    • Increased demand for digital transformation services: Companies are increasingly investing in digital transformation initiatives, driving demand for IT infrastructure modernization and cloud migration services.
    • Ongoing migration to the cloud: Companies are increasingly adopting cloud-based infrastructure, creating new opportunities for cloud-related services.
    • Rapid data growth: Data volumes are growing rapidly, requiring specialized storage, security, and management infrastructure.
    • Accelerated pace of technological advancement: The pace of new technologies are increasing at an exponential rate, creating new opportunities for companies that are flexible and adaptable to change.
  • Margins: Kyndryl’s gross margin is around 14%-15%, which leaves them exposed to profitability challenges, and this pressure on the margins may continue in the future.
    • The adjusted EBITDA margin is even worse, around 5-7%, which reveals they are having trouble with controlling costs of operations.
  • Competitive Landscape:
    • The IT infrastructure services market is quite competitive, with various competitors such as Accenture, Capgemini, TCS, and HCLTech. These competitors provide similar, or very similar, services as Kyndryl.
    • Many large technology companies have their own divisions for IT infrastructure management such as Amazon Web Services, Microsoft, and Google.
    • The market is characterized by large and small companies in the IT sector. The key thing for success is to build close relations with clients and provide an efficient experience.
    • Many companies are now using cloud and other technology capabilities to help their customers manage their own systems.
    • Competition is especially intense in the emerging technology trends such as cyber security, 5G, AI, and IoT, with different vendors creating solutions in each of these sectors.
  • What Makes Kyndryl Different:
    • Kyndryl positions itself as an independent pure-play infrastructure services provider, allowing it to be agile and focused on clients’ needs.
    • It offers a large global infrastructure delivery system, with a presence in multiple countries.
    • They utilize a flexible and scalable delivery system to help clients with managing costs.
    • They have proprietary tooling, automation, data analytics, AI capabilities, and a strong IP that are expected to lead the company to improved results.

Financial Analysis: Kyndryl’s financial situation presents a mixed picture of revenue, profitability, cash flow, and debt.

  • Revenue:
    • Kyndryl reported that revenue for the three months ended December 31, 2022, was $4.3 billion, decreasing by 6% when compared to the same period last year. The revenue was negatively impacted by contract modification (especially from a large European customer), foreign exchange rates and a decline in the company’s nonrecurring revenue streams.
    • The company expects revenue to be negatively impacted by the strong dollar against other currencies.
    • Revenues have been steadily declining over the last years, especially with the loss of major clients. The company must stabilize its revenues and focus on growth in the future.
  • Profitability:
    • Kyndryl reported an operating loss of $179 million for the three months ended December 31, 2022, a significant decline from the operating profit of $129 million reported for the same period last year. Adjusted EBITDA also decreased, from $414 million to $260 million.
    • These results indicate that the company has difficulties maintaining profitability. A few factors are the company’s lower margins which are affected by high costs, and a lack of higher-profitability business.
    • The company reports high operating costs with high S&A and selling expenses. The cost of selling services is usually very high, however, a proper cost structure will lead to improved performance.
  • Cash Flow:
    • Cash flow from operations for the three months ended December 31, 2022 was $156 million vs $109 million in the prior year. Cash position remains relatively strong.
    • Kyndryl has had to make use of borrowings to support daily operations. Further improvement in revenue and profitability is needed to stabilize and improve cash flow.
  • Debt:
  • The company has a lot of debt; they have both long term and current debts. This limits flexibility and the ability to take advantage of the investment opportunities available in this sector.
  • The company has been using leverage to finance operations, as well as new investments, but if this leads to an increasing interest expense, that could further lower the company profitability and could negatively impact future growth.

Risks to the Moat and Resilience:

  • Intense Competition: The IT services market is highly competitive. The competition of both companies that provide similar services, and technology companies which try to offer their own solutions could be dangerous to Kyndryl’s position. Also, because many customers are using cloud-based solutions, this could impact the need for IT outsourcing, which could weaken the demand for Kyndryl’s services.
  • Technological Obsolescence: The pace of technological change is extremely rapid. The development of new technologies may make Kyndryl’s existing infrastructure and service offerings outdated. This requires constant innovation to maintain their position.
  • Customer Concentration: A significant portion of Kyndryl’s revenue is derived from a few large customers. Losing a few large customers could cause the business to contract severely, leaving a big impact on revenues and profitability.
    • The loss of a large European customer was one of the main reasons for the contraction in revenues this past quarter.
  • Pricing Pressure: Due to the lack of significant differentiation between services, companies may lower their prices in order to attract and retain customers, reducing the overall profitability of the sector.
  • Economic Downturns: During an economic recession, customers may cut back on IT spending which will negatively impact the company.
  • Integration Risk: While the company has made an effort to try to improve its internal organization, there is still uncertainty whether these changes can achieve the desired results or lead to operational inefficiencies.
  • Dependence on Partnerships: If the partnerships that the company uses to deliver services deteriorates, or if they are no longer as good as they used to be, it can negatively impact the company’s services as a whole.
  • Talent Acquisition: As new technologies emerge, the ability to acquire and retain skilled employees is paramount to maintain leadership in the IT services sector.

Management Comments and Actions:

  • The company claims they are making investments in high growth areas which will help them with increasing the company’s performance, including the areas of security and cloud migration, and data and AI driven solutions.
  • Management has stated they will continue to implement a cost-optimization program over the next years.
  • They plan to use acquisitions to complement the company’s service offerings.

Moat Rating: 2/5 Kyndryl has a “Narrow” moat.

  • While the company benefits from its large scale and established relationships with customers, these factors are not unique enough to provide a wide moat.
  • The IT infrastructure services market is highly competitive, and the increasing use of technology could quickly diminish any competitive advantages that the company may obtain.
  • Because the cost of operations is really high with high SG&A and selling expenses, the company has trouble in maintaining profits and margins.

Understandability Rating: 3/5

  • The nature of the services provided by Kyndryl is easy to understand, they simply help companies with managing their IT infrastructure, but the details of each service and what makes the company successful, are quite complex.
  • The company’s financial statements are tricky to interpret, requiring a good understanding of accounting principles.
  • Because of the large variety of operations and offerings, as well as different levels of management, understanding the overall economics of the business can be complex for investors.

Balance Sheet Health: 2/5

  • Kyndryl has a moderate amount of cash, which can be useful for their operations, but they face increased risks due to heavy reliance on borrowings to fund operations.
  • Their short-term liquidity is somewhat weak and needs improvement, as shown by low current ratios.
  • They are in debt, and are making use of borrowings to fund the company, which makes the future risk higher.
  • Overall, the company’s balance sheet needs improvement, because there is a chance that current debts can cause major problems in their operations.