I've got a question for you: Why in the world would a company with more than $3 billion in cash, and no significant debt, raise $1.3 billion in the form of convertible senior notes?
Because on Monday, that's exactly what NVIDIA (NASDAQ:NVDA) announced it's going to do.
This morning, NVIDIA confirmed not only that the sale of the notes is expected to close on Dec. 2, but also that they will carry an ultra-low rate of 1% per year and be due in 2018. What's more, NVIDIA will grant the purchaser of the notes a 13-day option to buy up to an additional $200 million to cover any overallotments.
Here's why NVIDIA did it
NVIDIA, for its part, says it will use the net proceeds from the offering primarily to fund its recently announced $1 billion capital return program for next fiscal year.
But that still doesn't answer the question of why, exactly, NVIDIA decided to raise debt in lieu of using cash on hand to continue rewarding shareholders for their patience.
To answer that question, look no further than comments from CFO Colette Kress, who confirmed during the company's quarterly earnings conference call only one-fifth of NVIDIA's total cash, or around $600 million, resides here in the U.S. For some perspective, she says, that's generally about what NVIDIA needs to both run its business and pay for its quarterly dividend, which was increased by 13% last quarter to just over $0.08 per share.
In fact, Kress went on to hint at Monday's announcement, saying:
So with our intent going forward to return [...] to shareholders $1 billion in fiscal year '15, that will emphasize that we will come back with the options in terms of how we will do that going forward. [...] We will come back to you in about a quarter and give you a little bit more detail on those plans.
And remember, NVIDIA had around $1.5 billion domestically in the same year-ago period, much of which was used to cover the $983 million NVIDIA has already returned to shareholders so far this fiscal year.
Does this really make sense?
So unless NVIDIA wanted to bring all its foreign cash stateside and get hit with a massive, unnecessary tax burden (sound familiar, anyone?), it makes sense to raise debt to fund its capital return commitments.
Then again, convertible senior notes weren't exactly an obvious choice for a company with such a pristine balance sheet. On the surface, at least, it would have seemed to make more sense for NVIDIA to simply raise cash at a relatively low interest rate without resorting to such a potentially dilutive solution.
Let's do a little back-of-the-napkin math, shall we?
According to new details on the deal issued this morning, the initial conversion rate will be 49.5958 shares per $1,000 in principal. That's good for an initial conversion price of approximately $20.16 per share, or a premium of roughly 30% to yesterday's closing at $15.51 per share. Then, depending on whether the purchaser decides to exercise its overallotment option, NVIDIA expects the net proceeds to be either $1.28 billion or $1.48 billion.
All told, that means these convertible notes could potentially result in the issuance of roughly 63.5 million to 73.4 million new shares down the road, or an increase in the total number of shares outstanding by between 11% and 13%. Any way you slice it, that's a massive number of new shares which could ultimately undo much of NVIDIA's buyback intentions in the first place.
Then again, NVIDIA is also using $93.6 million of the net proceeds to negate some of its dilution risk with a series of hedge and warrant transactions designed to increase the price at which it must begin issuing the new shares. As it stands, the warrants' initial strike price will be $27.14 per share, or a 75% premium over yesterday's close.
Foolish bottom line
In any case, you can bet NVIDIA is hoping it can complete next year's buybacks at a significantly lower price to make this offering worth its while. And though it remains to be seen whether that will happen, if one thing's for certain, it's that NVIDIA appears confident its share price will increase significantly over the next few years as its long-term plans take hold.
In the end, I'll admit today's convertible debt offering may not be most straightforward route NVIDIA could have taken. But as a longtime shareholder myself, I'm willing to give this promising company the benefit of the doubt.