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
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
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
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.
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