The Long and Short
Kyndryl offers better value than ARW, AVT
This material is a Marketing Communication and does not constitute Independent Investment Research.
Kyndryl Holdings’ (KD: Baa2/BBB-/BBB) intermediate notes are some of the widest trading credits in the entire technology sector of the investment grade index. In fact, the recently issued KD 2034 10-year notes trade wider than any other ‘BBB’ tech name in that part of the credit curve for all index constituents. The only liquid, comparable ‘BBB’ technology credits that trade in similar context are the technology wholesale distribution credits Arrow Electronics (ARW: Baa3/BBB-/BBB-) and Avnet (AVT: Baa3/BBB-/BBB-). Considering that these companies operate at far thinner profit margins—approximately half those of KD—carry more net leverage and have lower ratings overall, KD offers a considerably better value.
Exhibit 1. KD compared to peers in the 5- to 10-year part of the credit curve
Source: Santander US Capital Markets LLC, Bloomberg/TRACE G-spread indications
KD was spun out of IBM Corp (IBM: A3/A-/A-) in 2021, creating a standalone global leader in technology infrastructure services, that is approximately twice the size of its next closest competitor DXC Technology (DXC: Baa2/BBB-/BBB) by annual revenue. Infrastructure services include cloud, core enterprise, AI and digital security. KD is well diversified geographically, generating only about a quarter of revenue here in the US. The company’s second largest market is Japan, which represents about 15% of generated revenue. KD benefits from the long-term nature of its service contracts, which typically run three to five years in duration, as well as the large and established nature of its core customers. The company generated about $17 billion in total revenue in fiscal 2023 and has generated about $16.5 billion on a trailing twelve-month basis as of fiscal third quarter of 2024 (reported in February of this year).
The issuance of the $500 million 2034 ten-year notes back in February improved upon an already stellar liquidity profile for the company, as proceeds were utilized to fund an upcoming loan maturity in 2024. The next public debt maturity is not until 2026. As of year-end fiscal 2023, the company had $1.7 billion of cash on the balance sheet, in addition to a $3.15 billion revolving credit facility available through 2026. The credit facility is large enough on its own to meet all combined debt maturities currently outstanding ($2.9 billion).
As stated, KD represents a much higher margin operating profile than the comparable trading technology distribution credits ARW and AVT. For fiscal 2023, KD reported an EBITDA margin of 11.6%, and for the lagging twelve months as of third quarter fiscal 2024, the company is running at about 13.8%. That compares with an EBITDA margin of 5.5% for ARW trailing twelve months as of fourth quarter 2023, and an EBITDA margin of 5.1% for AVT for fiscal 2023.
Since its inception in 2021, KD management has repeatedly expressed the company’s commitment to retaining investment grade ratings and so far, has appeared to put those priorities well ahead of any type of M&A growth strategy or shareholder remuneration goals. The company continues to operate with very conservative leverage metrics for its rating category and is targeting a very manageable range moving forward. KD’s gross debt-to-EBITDAiA (which includes the addition of amortization of tangible assets) for the trailing twelve months was 1.5x, while on a net basis they remained comfortably below the 1x threshold. They are projected to remain in a similar range for the next three fiscal years according to the rating agencies. By comparison, net leverage for the technology wholesale distribution credits has remained closer to 2x during the past year.
KD reported fiscal third-quarter earnings on February 7, recording total revenue of $3.94 billion versus the $3.92 billion consensus estimate and an adjusted loss of $0.05 per share. Management raised its adjusted pretax profit guidance for the full year to $150 million from $140 million, while keeping its EBITDA margin outlook of 14.5% intact. Re-booking of long-term contracts over the next several years presents a credit risk to the company, given the fractured and highly competitive nature of the industry.
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