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Why Did Intel Buy McAfee?

By Andrew Bond – Updated Nov 9, 2016 at 7:39PM

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What exactly will the chipmaker do with a security software specialist?

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.

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Stocks Mentioned

Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$232.90 (-1.94%) $-4.60
Intel Corporation Stock Quote
Intel Corporation
INTC
$25.77 (-2.31%) $0.61
NortonLifeLock Inc. Stock Quote
NortonLifeLock Inc.
NLOK
$20.14 (-1.13%) $0.23
Skyworks Solutions, Inc. Stock Quote
Skyworks Solutions, Inc.
SWKS
$85.27 (-4.47%) $-3.99
Oracle Corporation Stock Quote
Oracle Corporation
ORCL
$61.07 (-0.54%) $0.33

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