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nonzerosum (44.78)

Intel’s dividend is a joke – it could double EPS with a buyback



November 16, 2010 – Comments (7)

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.

7 Comments – Post Your Own

#1) On November 16, 2010 at 4:00 PM, SkepticalOx (98.33) wrote:

Honestly, the cash is there in case things go kaput and to invest in the future. As nice as an all-in buyback sounds, the markets Intel is in are rapidly changing, and their revenue and income streams are not secure. Intel isn't as dominant as it should be in the mobile-devices market, and that's where the growth is. Honestly, you think using all their cash for a buyback and essentially making their debt sky-rocket would let them borrow at only 4%? Are you serious?

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#2) On November 16, 2010 at 4:04 PM, truthisntstupid (77.26) wrote:

I and millions like me would no longer be interested in buying it, either.

LBOs have NOT been good for companies involved.

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#3) On November 16, 2010 at 4:15 PM, chk999 (99.96) wrote:

I assume this is a joke right?

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#4) On November 16, 2010 at 5:10 PM, dbjella (< 20) wrote:

I hope they continue the div route

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#5) On November 16, 2010 at 6:41 PM, truthisntstupid (77.26) wrote:

This will never happen because people remember the lessons of the past.  When KKR got done sucking the life out of RJR Nabisco, they "only"  left them saddled with $10B in debt.  RJR Nabisco was a conglomerate giant, owning RJ Reynolds, Nabisco, and several other valuable brands.  But its earnings were depressed for years and it traded at $6/share for a LONG time.  I know.  I owned some. 

At the time that $10B LBO was the largest LBO in history and it crippled one of the country's largest, most successful conglomerates. 

It had once been a financial juggernaut with a fortress-like balance sheet, too.


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#6) On November 16, 2010 at 11:08 PM, RHinCT (69.87) wrote:

The most hilarious part of this is the assumtion that they can buy back two thirds of the company with ALL of it at the SAME $20 per share, and only THEN will the price go up.  Do you think maybe all that buying activity - two thirds of all the shares - just might push up the price a bit even before anyone figured it out?  Much less that it could all be accomplished without anyone figuring it out?  Or that more than 1/3 of the shares might be in the hands of people (or institutions) that are not interested in selling when the price is low?  (59% of the shares are held by institutions or mutual funds.)

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#7) On November 17, 2010 at 9:06 AM, nonzerosum (44.78) wrote:

#1 (SkepticalOx). Serious.  Only 14% of their operating income would go to interest.  That means earnings could collapse by 86% and Intel could still pay its debt.

#3 (chk999).  Yes, the LBO gig is a joke - I wouldn't want a stressful life on wall street.  Besides, Intel probably has a poison pill. And no, the whole article isn't a joke.  This is what Bernanke is hoping corporations would do, but the board rooms haven't caught on yet.

#5 (truthisntstupid). The LBO firm would never execute or complete the buyout.  They buy calls, borrow enough cash for a credible threat (see below) and cash out when the price rises to equilibrium.  Call volume would move the market, of course, so maybe they do a private transaction with an institution...

#6 (RHinCT) Exactly.  All Intel has to do is to complete the debt offering and its shares would shoot up.  It wouldn't have to buy anything. The key is to have a credible threat.

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