Intel's (NASDAQ:INTC) stated philosophy regarding capital allocation is as follows:
- Invest in the business itself through R&D, capital expenditures (think big, expensive chip factories), and acquisitions
- Stock buyback
Under "normal" circumstances, Intel generates so much free cash -- the amount of cash left after operating costs and capital expenditures -- that the company can easily support a generous dividend and fairly significant buyback activity.
During 2016, however, I don't think investors should count on much in the way of share repurchase activity from the chip giant. Here's why.
Remember Intel's Altera purchase?
Intel announced earlier this year that it plans to acquire FPGA maker Altera (NASDAQ:ALTR) for around $16.7 billion. In order to fund this purchase, Intel needs to issue around $7 billion in debt.
At the end of the most recent quarter, Intel had net cash of around $5.1 billion. Once the Altera deal closes, Intel will have to part with around $14.3 billion (per Bloomberg) once Altera's net cash on hand is subtracted from the purchase price.
Had the deal closed at the end of the most recent quarter, Intel's net debt position would have been around $9.2 billion.
Intel has made it clear that it wants to operate its business at around a zero net cash balance. During the company's most recent investor meeting, CFO Stacy Smith said the company expects to bring its net cash balance back to around zero by the end of 2016.
This probably means very limited buyback activity in 2016
If the combined Intel and Altera entity generates around $13 billion in free cash flow next year (a bit higher than the ~$12 billion it expects to rake in this year) then, once we subtract out dividend payments of around $5 billion, the remaining $8 billion will need to be used to pay down debt for the company to hit its net cash target.
This leaves very little room for the company to repurchase stock in the coming year. In fact, if Intel plans to be at zero net cash by the end of 2016, I'd expect the company to report that it did very little in the way of share repurchase in the final quarter of 2015.
As a long-term investor, I'm totally fine with that
Although buybacks are nice in that they help reduce a company's share count (boosting earnings per share for a given level of net income), I'm not going to complain if the company largely suspends its share repurchase program.
Share repurchases do, in fact, deliver value to shareholders, and I think investing in smart acquisitions that can significantly strengthen a company's business -- and I think Intel's Altera buy has the potential to do this -- are far more important over the long run than share buybacks.
Indeed, if Altera allows Intel to generate billions more in additional high-margin revenue (particularly once Intel integrates Altera's FPGAs with its Xeon processors), in time the company will be able to increase its dividend even further and will be able to return even fatter amounts of cash via the buyback.
What about a dividend increase in 2016?
Intel increased its dividend for 2016 during its November investor meeting to $1.04/share. Since Intel should be back at around zero net cash at the end of 2016, and since it's pretty likely Intel will forecast growth for 2017, I'm comfortable in expecting yet another dividend increase for 2017.
Ashraf Eassa owns shares of Intel. The Motley Fool recommends Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.