How Cisco Could Become a Dividend Legend

Cisco Systems (Nasdaq: CSCO  ) is tapping an all-star cast of investment banks to arrange fresh loans. The networking giant will sell an undisclosed bunch of senior debt notes, then use the proceeds for "general corporate purposes" -- which could mean anything.

At the same time, we know that the company plans to start paying dividends. This new debt will get dumped right into that effort, or else used to refill the coffers after the dividend payments take their toll. Either way, it's a pretty direct move to restructure Cisco's balance sheet and keep the dividend flows healthy.

Our little networker is growing up!

Who are you calling "little?"
All kidding aside, loading up on debt while borrowing is cheap is an eminently traditional move. Doing so can fuel expensive expansion plans, like acquisition sprees or building new bricks-and-mortar locations. The strategy can also pump up dividend streams as the company becomes less concerned with keeping low-debt cash reserves on hand. Look at fast-food giants McDonald's and Yum! Brands to see two fine examples of all of these components in the debt-powered leverage strategy.

Fellow tech titan Microsoft (Nasdaq: MSFT  ) set the standard for this tactic by raising its first $3.8 billion while debt financing was cheap in 2009. Mr. Softy evidently got a taste for debt papers; it now carries a debt load of $9.7 billion, against cash equivalents and short-term investments adding up to roughly $40 billion.

Cisco is no stranger to big loans, however. Its acquisition habit can get costly, and Cisco already has $12 billion of loans to service. The bank is also holding some $40 billion of Cisco's cash and investments, much of it spread out across the globe and difficult to get back home without paying dearly when the tax man comes a-knocking. Rather than pay a potential 35% tax hit on most of that foreign cash, Cisco's relying -- much like Microsoft -- on raising cheap debt to fuel a healthy dividend. That's life in megabig business.

Moving on, growing up
Some giants prefer squeaky clean balance sheets with no debt at all, including market darlings Google (Nasdaq: GOOG  ) and Apple (Nasdaq: AAPL  ) . They, too, will grow up one day, probably start paying dividends and possibly taking on loans of some kind to make it a painless experience. Not counting really old-school techies, Microsoft got its AARP card first, and now Cisco is following suit.

None of this takes away from Cisco's value -- it just makes the stock into a different class of investment. CEO John Chambers won't be caught dead admitting that his days of heady growth are over, but the stock is clearly moving out of high-growth territory and firmly into the value side of things.

If the dividend turns out to be both strong and supportable, it might even become a favorite of income investors. Imagine that.

Yeah, let's imagine that!
Here's how that income-generation thing could play out.

Cisco tends to generate about $9 billion of free cash flow a year. To achieve a respectable 2% yield at today's prices, Cisco would have to pay out about $0.35 per share, or $2 billion a year, which doesn't sound terribly onerous, given that enormous cash machine at Cisco's back and its ability to raise cheap debt if need be.

The Standard & Poor's ratings bureau has already assigned a solid A+ rating (a perfect one would be AAA) to Cisco's new loans, under the assumption that the company will keep $10 billion-$15 billion of net cash on hand (after considering that costly 35% repatriation tax).

Assuming that Cisco's end markets stay healthy for the foreseeable future, which seems perfectly reasonable to me, you'd end up with a fat lump sum to get started, followed by strong, safe, and presumably growing regular payouts for a very long time.

Cisco and Microsoft might even join the much-vaunted list of Dividend Aristocrats, finally putting some tech-industry mojo on that list. Today, the closest thing to a high-tech business you'll find there is credit-card processor Automatic Data Processing (NYSE: ADP  ) . To make that hallowed list, companies must simply keep growing those dividends, without fail, for 25 years or more.

Whatever Cisco ends up doing with its borrowings, and however the dividend play unfolds, you can follow it all in high-definition detail by adding Cisco to your Fool watchlist. Adding your first stock to that list also gives you immediate access to a free report and some other goodies. Get going right now -- it's free!

Google and Microsoft are Motley Fool Inside Value recommendations. Google is a Motley Fool Rule Breakers recommendation. Apple is a Motley Fool Stock Advisor pick. Automatic Data Processing and McDonald's are Motley Fool Income Investor recommendations. The Fool has written puts on Apple. The Fool has created a bull call spread position on Cisco Systems. Motley Fool Options has recommended a bull call spread position on Apple. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Apple, Google, Microsoft, and Yum! Brands. Motley Fool Alpha owns shares of Cisco Systems. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


Read/Post Comments (14) | Recommend This Article (21)

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  • Report this Comment On March 11, 2011, at 11:22 AM, TMFBreakerForce wrote:

    Hi Anders,

    Just one comment to your very nice article. Cisco has already launched their Senior Note offering, on 3/9/11 which was not a bank loan.

    They sold:

    $2bln of 4 yr notes at 1.625% (wow)

    $1.25bln of 4 yr floating rate notes

    $750mln of 6 yr notes at 3.15%

    $4bln total.

    Best,

    Matt

  • Report this Comment On March 11, 2011, at 11:58 AM, TMFBreakerForce wrote:

    Hi Anders,

    Thanks for the great article.

    Just wanted to point out one thing:

    Cisco actually raised the $4 billion in Senior Notes, not Bank debt on 3/9/11.

    Broken out as follows:

    $2 billion of 1.625% notes due 2014 (nice)

    $1.25 billion floating rate notes due 2014

    $750mln of 3.15% notes due 2017

    Best,

    Matt

  • Report this Comment On March 11, 2011, at 12:05 PM, jimmy4040 wrote:

    CSCO would probably do MUCH better to stop giving out stock options like candy for the last 10+ years which has placed a celing on their stock price in the good times. You can see how the marketplace views dividends for tech companies (spelled MSFT) so a dividend is not going to make up for their recently quarterly misses.

  • Report this Comment On March 11, 2011, at 12:35 PM, TheDumbMoney wrote:

    jimmy, how the market views dividends from tech companies is quite amusing, and quite supports purchasing stocks in such companies now as a part of one's portfolio, in my view. It is no coincidence that MSFT is one of the single largest if not the single largest individual stock components of Ray Dalio's portfolio. MSFT at 9.5 forward P/E (9.2 earnings yield), 12.7 cash return, 0.8 PEG ratio, asset turnover 80% higher than it was a decade ago, ROE strong, dividend hiked nearly 20% this year, and it's currently sporting its highest operating and net margins in six or seven years?

    Yes please, I'll take two, and one for the lady. And some Cisco, too. The moo-mooing about cloud computing reminds me a lot of Y2K fears, among other things.

  • Report this Comment On March 11, 2011, at 1:03 PM, BradReeseCom wrote:

    Hi Anders,

    During Cisco's Q2'FY11 earnings call, Cisco EVP and Chief Financial Officer - Frank Calderoni, appeared to state for financial transparency purposes:

    "For the quarter, we repurchased $1.8 billion of common stock under the stock repurchase program or 89 million shares at an average price of $20.15 per share. The remaining approved amount for stock repurchases under this program was approximately $12.7 billion as of quarter end."

    However, yours truly was not impressed.

    Why not?

    Well, because Calderoni conveniently omitted that Cisco reduced its outstanding share count by a mere 44 million shares (i.e. 5,577 billion - 5,533 billion = 44 million) during Q2'FY11.

    That means a whopping 45 million shares (i.e. 50.56% and/or $910 million in Cisco shareholder cash) of Cisco's total Q2'FY11 stock buybacks went to support Cisco's dilutive management compensation practices!

    Interestingly, stock buybacks were first authorized by Cisco's board in September 2001. So over the past 10-years the number of Cisco shares outstanding has decreased by 1.768 billion shares, however, Cisco has actually repurchased a total of 3.329 billion shares at a a weighted average price per share of $20.81

    That means a staggering 1.561 billion of Cisco's shares that were repurchased (i.e. $32.484 billion of Cisco shareholder cash), went to support Cisco's dilutive management compensation practices over the past 10-years.

    Finally, Cisco CEO John Chambers thinks so highly about the "appreciation potential" of Cisco's stock that he has more of his money tied-up in his personal jet (for which Cisco shareholders pay the annual expenses, i.e. $2.2 million in FY2010), than he does in direct holdings of Cisco stock.

    I mean, you gotta love a CEO like Chambers who obviously has conviction in his stock's price appreciation potential.

    Sincerely,

    Brad Reese

  • Report this Comment On March 11, 2011, at 1:16 PM, TheDumbMoney wrote:

    Brad, Chambers is retiring within the next two years I think, and a dividend is finally coming. Don't look to the past ten years, look to the next ten. Cisco is in the midst of a corporate transition.

  • Report this Comment On March 11, 2011, at 2:29 PM, jimmy4040 wrote:

    Brad Reese: What you said!!!!

    dumber:

    Thanks for the reply. I'm always mystified why some investors will cite statiistic after statistic to support their arguments in favor of a stock that in some way rely on perfomrance over a past period of time. For instance in your case asset turnover, and increased dividend yield. (and there's nothing wrong wtih using those numbers)

    HOWEVER when someone like myself wants to use past share price performance as a possible indicator of future share price performance, the howling that goes on is like an Irish wake when the whiskey runs out!

    I have been told in no uncertain terms that either share price itself is meaningless, or PAST share price performance is meaningless (and in the case of MSFT, it's hard to argue the point because past share performance has certainly BEEN meaningless LOL).

    Why is it ok for long investors to do so, but not short ones?

    (In case you're wondering where I stand, it's Ballmer's fault, and it might be cured relatively quickly if he leaves, depending on his replacement)

  • Report this Comment On March 11, 2011, at 4:52 PM, TheDumbMoney wrote:

    jimmy, well-said. However my use of past statistics for Microsoft, in my mind anyway, is not used to justify the decision to buy, going forward. Rather, with MSFT, my use of past statistics (again how I see it) is to demonstrate that just because MSFT's stock price hasn't gone anywhere for ten years, that does not mean it has gone down the toilet operationally. Ultimately, my forward-looking cash flow analysis is what says MSFT is a buy. As for CSCO, my point is that there have been some signifincantly negative things in the last decade, but CSCO appears to be at an inflection point; the reason why the past is not as relevant is because it is at an inflection point (Chambers retiring, dividend, recognition it's not a growth co. that can hand out options willy-nilly).

    Finally, I submit that while we ultimately should look to the future, there is a huge difference between looking at past improvement in operational metrics (to extrapolate future improvement), and simply looking at what the stock price has done. Stock prices simply are not always tethered to reality, and can be arbitrary. In short, the price of a stock, and all technical analysis, ultimately resolves down to psychology, and herd dynamics. But the operational metrics are fundamental, and real, and speak for themselves.

  • Report this Comment On March 11, 2011, at 5:46 PM, BradReeseCom wrote:

    John Chambers retire?

    Over the most recent 5 years (according to Forbes Magazine on April 28, 2010), Chambers has averaged $39 million per year in compensation.

    Back on July 27, 2009 I blogged:

    Cisco CEO John Chambers to stay at Cisco for another decade or more?

    Cisco's official statement to my blog story:

    Brad -

    You have mischaracterized the editorial in this weekend's Wall Street Journal in your headline today. The section from the Journal article in question reads:

    "And it’s why he’s reorganized Cisco around small, fast-moving product groups—called councils and boards—and sent them off in hot pursuit of markets in full expectation of every one turning into a billion-dollar business.

    "Unrolling all of that may take a decade or more, and John Chambers intends to be around to see it happen. He certainly has the genes for it: His father, 84, remains his most trusted adviser."

    The author was making a comment about John's health and not his tenure as Cisco CEO. Last year, Mr. Chambers committed to the board for an additional term as Chairman and CEO for 3-5 years.

    John Chambers is "milking" too much money from Cisco ($39 million per year) to ever announce his retirement!

    Sincerely,

    Brad Reese

  • Report this Comment On March 11, 2011, at 6:38 PM, TheDumbMoney wrote:

    Fair enough, I was misremembering that date. But they have publicly committed to starting a dividend before July 2011.

    Frankly, from a governance perspective, I'm much more concerned about the fact that John Chambers is both Chairman and CEO than I am about the simple fact that he makes $39 million per year.

  • Report this Comment On March 11, 2011, at 6:45 PM, jimmy4040 wrote:

    dumber wrote:

    "Stock prices simply are not always tethered to reality, and can be arbitrary. In short, the price of a stock, and all technical analysis, ultimately resolves down to psychology, and herd dynamics. But the operational metrics are fundamental, and real, and speak for themselves"

    Which is why if Wall Street were a supermarket, MSFT would be a star, but in the reality of the auction place where values are subjective, not objective, MSFT has been, is, and will continue to be dead money!. (until the ultimate plow horse Ballmer leaves)

  • Report this Comment On March 11, 2011, at 6:51 PM, jimmy4040 wrote:

    Brad

    CSCO is an easy company to own. Chambers believes that you manage a company for the employees, not the shareholders. That's why he consistently dilutes the stock.

    So, you buy the company between 15-18 and you sell between 23-26. what could be easier? You never risk it going above that number too much and making you look like an idiot for selling. You never risk it going below that number much and losing a lot of money. LOL

  • Report this Comment On March 11, 2011, at 7:00 PM, TheDumbMoney wrote:

    Jimmy, in your last paragraph, I agree wholeheartedly with "has been, is" but I don't agree with "will continue to be."

    Given the revenue growth and EPS that MSFT is expected to show, and their free cash flow, or even if they get anywhere near to it, it is mathematically impossible for MSFT to be as dead as it has been for the last decade, unless the P/E ratio goes down to about 3. Psychology plays a huge role, but in the end objective reality will trump pychological prejudice.

    Neither of our opinions matter that much though, so here's hoping you having some fun and making some money!

  • Report this Comment On March 12, 2011, at 7:26 PM, Dima wrote:

    "Today, the closest thing to a high-tech business you'll find there is credit-card processor Automatic Data Processing" ---

    ADP is a payroll processor, not a credit-card processor. How do your editors miss that?

    Otherwise, CSCO dividend would be a nice start to compensate for an otherwise pathetic stock performance.

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