Wednesday, August 17, 2005

Why 3% dividend yield is tough for Cisco

There has been a lot of talk recently, particularly by Larry Kudlow on CNBC on why Cisco should pay a dividend to move the stock higher. Larry even believes the stock can "double" if CSCO paid a 3% dividend yield. Here is why I think 3% dividend yield is a tough act for CSCO.

3% dividend yield would mean $3.967B (assuming 6.612B shares outstanding and $18 share price). CSCO can't afford to pay out $4b in cash every year (and grow the dividend).

Why you might ask? Because they have to continually buy back shares to issue to employees. Looking at some numbers it becomes clear how much CSCO uses its cash to buy shares for employees benefit.

All numbers are as of Year ending July 30,2005

CSCO generated $7.56B in cash from operating activities and then spent $692M for cap ex and spent another $911M for acquisitions. Leading to FCF of $5.96B (equates to FCF yield of 5.11%- not bad if you are a value investor) which would be plenty to pay a $3.9B dividend a year. But then CSCO management had to buy $10.23B of stock last year - 18% of which they had to pay out to employees.

How do we know that this stock was for employees? Because CSCO shares outstanding only declined by 445 million during the year. That would mean Cisco's avg price on buy-back was $23- the stock has been well below that price through out the yr (july 2004-july2005). Also CSCO mgmt stated that they purchased total of 540 m shares throughout the year in their conf calls as detailed below:

Q1 bought back 156m shares ($3b @19.24)
Q2 bought back 140m shares ($2.7b @ 19.30)
Q3 bought back 114m shares ($2b @17.91),
Q4:bought back 130m shares ($2.5b @19.14)

While Cisco's balance sheet has $16B in cash today, it had $19.3B last year, a decrease of $2.652b in one year, which is exactly how much shareholder equity declined by over the year. With continued dilution from options and shareholder purchases for employees it becomes tough for CSCO to take that cash and send it to shareholders in a form of a dividend. Yes, the share repurchases help stock holders indirectly but it also helps employees directly and more lucratively. As option expensing comes into fore front expect CSCO to issue more shares instead of options which means they would have to buy even more shares for employees then they do currently.

We have to wait for the 10K to see where the employee options are priced and what amount of these options are in the money vs. waiting to be vested- a key factor for CSCO purchases for employees. Also with stock being "dead" for so long, retention has become an issue and its impacting morale- that's why I think CSCO could start increasing compensation this year after such a long time. Bottomline: CSCO is in a tough middle ground where its not really a growth company any more and it isn't a value stock either.


Anonymous Anonymous said...

It really is beyond my comprehension how Kudlow has a TV show. He is a Larry one-note who parrots the "all is great with the Bush-led USA"

5:51 PM  
Anonymous Anonymous said...

They still should pay a dividend, maybe not 3%, but taking your calculations into account and leaving some on the side for acquisitions, why not 1.5%?

6:58 AM  
Blogger xocoatl said...

Gee ... it's almost like stock options are an expense!

9:25 PM  
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10:08 PM  

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