Intel’s dividend is a joke – it could double EPS with a buyback
Intel recently made much fanfare about their $0.18 dividend increase. Are they trying to help investors and beleaguered pension funds? Well, if Intel is serious about returning value to shareholders it should initiate a buyback right now. A massive buyback. Intel could double EPS overnight and the stock would follow. Failing to do that amounts to fiduciary negligence by the board and management. .
Here’s how it would work. Intel has about 5.6B shares outstanding. It can use its $20B cash hoard to repurchase about 1B shares at $20 each. Then it can issue $56B in debt to repurchase another 2.8B shares. With only 1.8B shares left and $9.8B in net income, EPS would sky rocket to more than $5.50. At a P/E of 10 I’ll let you calculate the new stock price.
Bear in mind that $56B of new debt is very conservative because Intel would have still have a generous 7x in interest coverage. The company pays less than 3% interest on its existing bonds that mature 25 years from now. If Intel increases its existing $3B debt by another $56B it would probably have to pay closer to 4% . The total annual interest expense on the $59B would be roughly $2.4B and it is all tax deductible – a $720M gift from the IRS every year! See the charts below for the before and after operating income allocation (based on the latest quarterly financials, annualized).
What’s going on here - free lunch?
Nope, no free lunch. There are two things creating value:
1) I’ve already mentioned the $720M gift from the IRS every year. That’s because interest expense is tax deductible. It’s called the “tax advantage of debt” and every 1st year MBA learns about it.
2) Then you have the spread between Intel’s free cash flow yield of 10% and the 4% they can borrow at (driven by a 2nd gift from the government: QE2 induced low interest rates). It is really an arbitrage opportunity for Intel because they can earn that spread risk free. Think of it as taking the present value of 6% on $56B. Nice!
Wouldn’t the stock go up?
Yes. If word got out that Intel was going to do this the stock would double before they could complete the buyback. That’s the whole point. Intel stock is undervalued relative to interest rates. My argument is that stocks and interest rates do not live in separate universes. Why? Because blue chip companies can borrow at prevailing interest rates. Some have already started borrowing and Intel should too.
Why hasn’t Intel already done this?
I’m not sure, but interest rates won’t stay low forever (and if inflation picks up then this strategy will look doubly smart). Intel needs to move on this. I’ve been accumulating shares so that I can run a proxy vote on this proposal, but I’m a bit short ;-). If you manage a pension fund please contact me. Better still, if you have friends at a deep pocketed LBO firm then let them know I’m looking for a gig.