Why Cisco Systems' $8 Billion Debt Offering Is a Good Move

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Technology giant Cisco Systems (NASDAQ: CSCO  ) made waves with one of the largest bond offerings in technology industry history, and its shares fell on the day of the announcement. On the surface, it seems like a company taking on debt is little cause for celebration. After all, debt can become a burdensome anchor on a company's ability to grow.

However, with interest rates still sitting near historic lows, it actually makes perfect sense for cash-rich technology juggernauts to issue debt. That's particularly true since most of big tech's cash is held internationally, which would be subject to repatriation taxes if it's brought back to the U.S. Fellow technology behemoth Google (NASDAQ: GOOGL  ) sold $1 billion worth of 10-year notes just last week. And, Cisco is struggling to gain traction in its key markets for future growth. That's why issuing low-cost debt to fund its strategic growth initiatives is a wise move for Cisco.

Cisco muddling through
Cisco reported an 8% decline in both revenue and adjusted earnings per share in the most recent quarter. The company is still doing fairly well at the enterprise level, indicated by the fact that commercial product orders increased 1% in the second quarter. However, Cisco is seeing severe disruptions internationally, particularly when it comes to the emerging markets. Speculation of economic slowdowns in the emerging economies are gaining traction, since a slew of technology giants are reporting difficult business conditions in under-developed nations.

Cisco's Europe, Middle East, and Africa segment posted a 2% decline in product orders in the second quarter. This performance was actually a bright spot in comparison to Cisco's operations in Asia, where product orders fell 5% in the most recent quarter.

Meanwhile, smaller rivals are stealing Cisco's thunder in the emerging markets. Juniper Networks (NYSE: JNPR  ) grew revenue by 12% in its most recent quarter, which represented the sixth consecutive quarter of year-over-year revenue growth. The major reason for this is that Juniper is thriving in the emerging markets. Its Asia-Pacific region posted an 18% increase in quarterly revenue.

Going forward, concerns abound regarding Cisco's near-term direction. Management expects the fiscal third quarter to be difficult as well. Revenue in the current quarter is projected to decline another 6%-8%, calling management's vision for growth into question.

Financing needed to propel growth
Despite its current struggles, Cisco is committed to the emerging markets. To engineer a turnaround, the company will need to keep spending. Issuing debt will give room for Cisco to execute on its growth priorities, and the current interest rate environment makes now the perfect time to issue debt.

Cisco is selling $8 billion worth of investment-grade bonds with varying maturities between 2014 and 2024. The longest-dated bonds, which mature 10 years from now, yielded 3.6% when priced. That level of yield is only about 90 basis points above the 10-year U.S. Treasury Bond, and only slightly above Cisco's current dividend yield. Google's $1 billion bond issuance carried a yield of 3.37% for its 10-year notes.

The Foolish conclusion
Shares of Cisco declined after the bond sale, but this should be an accretive move to shareholders in the long run. A company gorging on debt is obviously scary, but technology giants like Cisco have a lot of cash on the books. Issuing debt is simply a way to leverage their strong balance sheets without repatriating foreign cash and having to pay a hefty tax bill.

At the end of the most recent quarter, Cisco held $47 billion in cash and short-term investments on its balance sheet. That amounts to more than 40% of Cisco's entire market capitalization. It's clear that Cisco isn't getting much credit from the market for its cash hoard, so the debt issuance is a smart way to unlock shareholder value and finance its strategic growth initiatives. Furthermore, it's likely that all that cash on the books is earning little to nothing in interest. That's why Cisco's huge bond sale shouldn't scare investors.

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  • Report this Comment On February 26, 2014, at 2:58 PM, BradReeseCom wrote:

    Hi Bob,

    With regard to your following "inaccurate" statement:

    "To gain traction in its key markets for future growth. That's why issuing low-cost debt to fund its strategic growth initiatives is a wise move for Cisco."

    So why am I calling your statement inaccurate?

    Because Cisco's NOT using the $8 billion to fund strategic growth initiatives.

    I mean, Cisco's most recent Form 10-Q for Cisco's Q2'FY14 shows $4.762 billion of short-term debt:

    Versus a year-over-year comparison when just a mere $37 million in short-term debt was on Cisco's balance sheet during Q2'FY13:

    Cisco will be using the ENTIRE $8 billion bond proceeds to pay down its current $4.762 billion of short-term debt as well as fund Cisco's stock buybacks as specifically detailed by Cisco CFO Frank Calderoni during Cisco's Q2'FY14 earnings conference call:

    "I am pleased that in the first half of FY'14, we have returned in excess of the 150% of free cash flow to our shareholders comprised of $6 billion of share repurchases and $1.8 billion a dividend.

    "In addition, today, our board approved an increase of $0.02 to the quarterly dividend to $0.19 per share an approximate 12% increase, representing a yield of approximately 3.3%. This dividend increase, combined with the anticipated share repurchases in the second half of the fiscal year, would comfortably exceed a return of over 100% for the full fiscal year of our free cash flow.

    "In Q3, we anticipate incurring additional debt to refinance our maturing bonds and enhance our domestic cash balances to support our ongoing commitment of returning cash to shareholders."

    So Bob, why do you inaccurately state:

    "To gain traction in its key markets for future growth. That's why issuing low-cost debt to fund its strategic growth initiatives is a wise move for Cisco."


    Brad Reese

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Bob Ciura

Bob Ciura, MBA, has written for The Motley Fool since 2012. I focus on energy, consumer goods, and technology. I look for growth at a reasonable price, with a particular fondness for market-beating dividend yields.

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