Why Did Intel Buy McAfee?

If Intel's (Nasdaq: INTC  ) acquisition of security software giant McAfee (Nasdaq: MFE  ) is any indication of what technology companies will be doing with the abundant cash on their balance sheets, perhaps they should follow Skyworks' (Nasdaq: SWKS  ) lead and just buy back shares instead.

Cash is king … sometimes
Last week, I criticized growth company Skyworks for spending $200 million to buy back its own stock. Skyworks does spend much of its cash on research and development, but in a cutthroat industry that is expected to grow more than 42% in the next two years, there's always room for more R&D.

Many commentators and experts would have you believe that cash-flush corporate balance sheets are stronger than they've been in years. However, many companies have found little to do with all that cash; growth opportunities have stagnated as the economy sputters. This excess cash on corporate balance sheets is essentially just burning a hole in their pockets.

Intel: better than ever?
Just about a month ago, Intel trumpeted what it called its "best quarter ever." Company executives couldn't heap enough praise on themselves for growing year-over-year revenue by 34% in such a tough economic environment.

However, after a one-day pop following the initial news release, the stock has traded lower, revealing investors' flagging enthusiasm about future growth. Perhaps they were aware that Intel was about to purchase a software security company that occupies a totally separate sphere from Intel's core chip business, and at a share price that the McAfee hasn't approached since the tech bubble in 1999.

The upside
While the acquisition will pose some problems for Intel, it will also create important benefits and synergies. Intel had about $18 billion in cash and short-term investments on its balance sheet. It's now purchasing a company with relatively large gross margin of around 80%, compared to Intel's 65% in the recent quarter -- a figure some believe might represent a peak for the chipmaker. And with many analysts believing that chipmaking and security will become increasingly entwined in the years ahead, Intel would likely have to enter this business somehow. Unfortunately, the route it chose was on the expensive side.

The downside
Like fellow information technology giant Microsoft (Nasdaq: MSFT  ) , Intel's stock performance has been lackluster over the past 10 years, even as it has increased earnings, maintained its lead in consumer-facing processors, and expanded its presence in servers. However, maintaining dominance hasn't been enough for investors, who look toward a future dominated by smaller, cheaper, more mobile devices. Intel has not shown the growth potential that investors are looking for in this sector, in part because it's been stuck with the label of "PC chipmaker." While Intel has belatedly made a foray into high-growth chip areas like the smartphone market, it's been unable to make great headway.

As a result, the company has sought growth in other areas as well. Companies such as Cisco (Nasdaq: CSCO  ) now tout tight security integration with their routers and Ethernet switches. While Intel might be pushing security features built directly into its "instruction sets," it'll still need software that takes advantage of such features. McAfee could come in handy here.

The deal would also be more favorable if Intel were acquiring a company firing on all cylinders. Instead, it paid a 60% premium from Wednesday's closing price for a stock trading at fifty-two week lows. McAfee was having trouble with its own recent acquisitions, made in an effort to keep up with its largest security software competitor, Symantec (Nasdaq: SYMC  ) . McAfee's reputation also recently took a hit from a defective virus signature update that disabled Microsoft (Nasdaq: MSFT  ) Windows XP operating systems on which its software was installed. McAfee blamed "inadequate quality control" for the meltdown.

I wasn't surprised to see McAfee get gobbled up by a larger technology giant; I simply expected Microsoft, IBM, or Oracle (Nasdaq: ORCL  ) to make the acquisition. Big buyouts like this one rarely fulfill the synergies their press releases often boast about. It helps if the companies are similar, and fit well into each other's business models. Unfortunately, that's not necessarily the case for this deal, which makes me wonder whether buying McAfee will benefit Intel in the long run.

Andrew Bond owns no shares in the companies listed. Try any of our Foolish newsletter services free for 30 days. The Fool has a disclosure policy. Intel and Microsoft are Motley Fool Inside Value recommendations. The Fool owns shares of and has written puts on Intel. Motley Fool Options has recommended buying calls on Intel. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Oracle. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (14)

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  • Report this Comment On August 24, 2010, at 4:31 PM, andantewalker wrote:

    In my opinion it's bad M&A. Intel is paying premium 60% for McAfee. It is stupid decision. How chip maker is planning to utilize software maker company?

    I just don't see it. Intel management is destroying shareholders value. Cost of acquisition is 7.7 bln. What is the cost of restructuring and merge? It's unknown. Buy back shares would better alternative. Unfortunately I do own Intel shares, and I have to admit I made a bad call.

  • Report this Comment On August 24, 2010, at 7:23 PM, TheDumbMoney wrote:

    I am an INTC shareholder, and have been a booster, though I have only been a shareholder for about a year and a half. But I'm seriously considering selling out based on this merger. I just haven't really worked through everything and satisfied myself on numbers to pull the trigger and sell. Subjectively, I don't buy the justifications, and I don't see how this is the best choice for that cash. To be clear, I don't see a ton of downside risk for INTC stock in the short term, given how relatively cheaply it is already trading, but this is the kind of thing that really makes you question the fundamental judgment of management, which for a long-term value-oriented investor obviously means a lot. I got around merger-issues with the PFE purchase of Wyeth, for example, because I really do think PFE had to do something like that given the Lipitor crisis. And, PFE at least purchased a company that does what it does. But this, what? Or maybe I just don't understand tech well enough to be investing in it, maybe I don't understand INTC's business as well as I thought I did? If you stipulate that chip-making will intertwine with security more-and-more, I'm no McAfee expert, but nothing I have read seems to indicate McAfee is really ahead in that area, or anything more than a pure software maker, so it's going to be new for them as well. Right? But maybe you get all the folks together and you get some synergies and new ideas. Maybe it helps create some more independence from Microsoft. I'd feel worse if INTC had purchased a trash hauler, or Hanson's soda, but still, a major head-scratcher for me.

  • Report this Comment On August 24, 2010, at 7:57 PM, plange01 wrote:

    if anyone can find out why intel bought mcafee let them know...

  • Report this Comment On August 24, 2010, at 8:53 PM, peters46 wrote:

    There was a rumor one or two weeks ago that INTC wanted to get on board with cloud computing. This would be an almost necessary step along the way to that end.

  • Report this Comment On August 25, 2010, at 12:50 AM, ChrisBern wrote:

    @peters46-- I disagree that buying a security software company "would be an almost necessary step along the way to (cloud computing)". Intel could've always OEM'd anything it wanted from McAfee, passing along royalty costs. It could've tried this out for a few year trial and, if the companies and technologies seemed to be a match, then they could've reconsidered an acquisition.

  • Report this Comment On August 25, 2010, at 10:26 AM, Ivan0310 wrote:

    @Bond "While Intel has belatedly made a foray into high-growth chip areas like the smartphone market, it's been unable to make great headway."

    I believe this is wholly untrue, the Intel Atom chipsets which have been in essentially every netbook to hit the market in the last year or so should be proof that Intel has made significant headway into the mobile computing market. Intel stated itself in its earnings report that the Atom hadn't cannibalized the sales of its traditional processors, meaning that the Atom line, which is about to get a refresh, has created a new cash-cow for Intel. I might also reference the fact that Atom processors have been introduced to mobile computers in automobiles and some version of the same chipset will be appearing in tablet computers as early as next year.

  • Report this Comment On August 25, 2010, at 10:26 AM, Pick1es wrote:

    I don't think Microsoft's ticker symbol is INTC...

  • Report this Comment On August 25, 2010, at 2:58 PM, drax7 wrote:

    I am feeling the same despair. Long the stock and now hurt by a merger that is maybe 10 degrees of separation from their competency level.Nobody so far can give a rational explanation for the synergies or the price offer.

    This is criminal in my opinion.

  • Report this Comment On August 26, 2010, at 4:02 AM, OmniCitadel wrote:

    Been thinking about the usefulness McAfee could bring to a hardware maker and it just dawned on me, Hardware based security.

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