What You Need to Know About IBM’s $19 Billion Spinoff – Motley Fool

The biggest move made by International Business Machines (NYSE:IBM) since CEO Arvind Krishna took the helm last year was the planned spinoff of the managed infrastructure services unit. The new company will be called Kyndryl, and it will be led by former IBM CFO Martin Schroeter.

Details have been scarce on the spinoff since it was announced in late 2020. On Tuesday, Kyndryl filed its Form 10 registration statement with the SEC that filled in some of the blanks. Here's what IBM investors need to know.

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The plan has always been for IBM to distribute shares of Kyndryl to its shareholders in a tax-free transaction. We now know more about what that transaction will look like. IBM shareholders will receive at least 80.1% of Kyndryl's common stock when the spinoff is complete, with IBM retaining the remaining stake.

IBM plans to exchange its stake in Kyndryl for IBM debt over the following 12-month period. After a year, IBM won't hold any financial interest in Kyndryl if all goes according to plan. For IBM shareholders, no action is required to receive shares of Kyndryl.

Kyndryl is already a major player in the realm of designing, building, managing, and modernizing mission-critical technology systems. The company has 4,000 customers in more than 100 countries, and it generated $19.4 billion of revenue in 2020.

Kyndryl estimates that its current addressable market is $415 billion. That market is expected to grow by 7% annually, reaching $510 billion in 2024. Kyndryl's biggest growth opportunities over the next few years will be public cloud managed services, data services, security services, intelligent automation services, and managed services for edge environments.

Measuring the profitability of a business that's still part of a larger parent company can be difficult. On an unadjusted basis, Kyndryl produced a pre-tax loss of $1.8 billion and a free cash flow loss of $0.3 billion in 2020.

These numbers don't necessarily reflect how Kyndryl will perform once it's officially a stand-alone company. Among other things, Kyndryl's financials include allocations for marketing and global sales coverage design that aren't consistent with how the company will look once the spinoff is complete. If you back out the relevant items, Kyndryl produced positive free cash flow of roughly $0.7 billion.

IBM is giving up around $19 billion of annual revenue by spinning off Kyndryl, but it's not giving up all that much free cash flow. IBM reported revenue of $73.6 billion and free cash flow of $10.8 billion in 2020. Excluding Kyndryl, revenue would have been $57.5 billion and free cash flow would have been around $10 billion.

IBM will provide more details of its financial position and outlook for the post-separation period during a virtual investor briefing on Oct. 4.

While Kyndryl has a large market opportunity, managed infrastructure services is a labor-intensive business. Kyndryl will have around 90,000 employees, so revenue per employee will be just over $200,000. That's lower than Walmart, for comparison.

What remains of IBM will be less focused on low-margin services and more focused on high-margin software. More than half of IBM's revenue currently comes from services. When the spinoff is done, the majority of IBM's revenue will be tied to cloud software and solutions.

Hybrid cloud computing and artificial intelligence will be at the center of everything IBM does. IBM is betting that its large enterprise clients will opt for an infrastructure that mixes on-premises hardware and public cloud platforms, instead of simply going all-in on one of the major cloud platforms.

By removing $19 billion of slow-growing and low-margin revenue, IBM should have an easier time reporting consistent revenue and earnings growth in the years ahead. The company's on-again off-again flirtation with growth has rubbed investors the wrong way, and the stock has been stuck for years. This spinoff may be just what IBM needs to change the narrative.

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What You Need to Know About IBM's $19 Billion Spinoff - Motley Fool