Cisco Bondholders OK with Dividend

Networking company’s debt has moved in line with other bonds since the increase in its payout was announced.

Bondholders are giving Cisco Systems Inc. a free pass on its plan to reward shareholders with half its free cash flow this year as the biggest maker of computer-networking equipment cuts prices and jobs to increase profit.

Cisco’s bonds are trading at levels that imply it should be rated Aa2, according to Moody’s Corp.’s capital markets research group, two levels above its actual rating of A1. Cisco’s fourth-quarter results beat analysts’ estimates, and executives said this week that the company will raise its dividend 75 percent as part of a plan to reward shareholders with at least half the cash generated from operations.

The firm’s stock reversed a 4 percent 2012 decline to a 5.2 percent gain on the news. Bondholders of San Jose, California- based Cisco may not mind the shareholder largesse because of the firm’s “relatively strong balance sheet,” according to money manager Bonnie Baha of Los Angeles-based DoubleLine Capital LP.

“It seems they can walk the fine line between keeping stockholders happy and debt holders happy at the same time,” Baha, head of global developed credit at the firm, which oversees $40 billion and doesn’t own Cisco bonds, said in a telephone interview. “As long as they don’t get out over their skis in terms of making big acquisitions and keep interest aligned between shareholders and bondholder and management, it should be fine.”

Cisco’s bonds have fallen 0.9 percent in the past two days, about in line with the 0.7 percent decline for all the bonds in the Bank of America Merrill Lynch U.S. Industrial Corporates index. The company’s $3 billion of 5.5 percent notes due 2016 fell to 115.9 cents on the dollar, down 0.2 cent, to yield 0.89 percent on Aug. 15.

The company is raising its dividend to 14 cents a share, starting this quarter, from 8 cents, for a yield of 3.2 percent.

Cisco won’t have to issue debt to fund the dividend increase, according to Kristin Carvell, a company spokeswoman. Its shares surged more than 9 percent after the announcement to close at $19.02 in New York trading yesterday.

The dividend doesn’t affect the rating for Moody’s analysts Richard Lane and Robert Jankowitz because the payouts as a percentage of discretionary cash flow is forecast to remain as low as 20 percent, compared with 40 percent for non-technology companies, they wrote in an Aug. 15 note. Discretionary cash flow is cash from operations minus capital expenditures.

Chief Executive Officer John Chambers has cut 7,800 jobs, shut businesses and reduced prices to win business lost to Juniper Networks Inc. and Hewlett-Packard Co. and combat a slowdown in Europe.


Domestic Cash

Cisco, a beneficiary of the growth in data that needs to be shuttled among servers, mobile phones, search engines and video websites, reported profit Aug. 15, excluding some costs, of 47 cents a share. That compared with the average estimate of 46 cents in a Bloomberg survey for the fourth quarter, which ended July 28. 

The company, which has been an advocate for a tax break on overseas profits, doesn’t need the “repatriation” holiday to fund the dividend, Chambers said during an Aug. 15 conference call to discuss fourth-quarter results with analysts and investors. Of Cisco’s $48.7 billion in cash and investments, only $6.2 billion was available in the U.S. at the end of the last quarter, with about $42.5 billion parked overseas.  

Demand for networking equipment has been weak in Europe, in India, and from government agencies, Chambers said on the call.

Europe, which makes up about 20 percent of sales, is “going to get worse before it gets better, and federal government spending is not going to improve in the short term here in the U.S.,” he said. Orders from Europe, the Middle East and Africa fell 6 percent from last year, the only region to experience a decline.

Chief Financial Officer Frank Calderoni said on the call that the company would return at least half of annual free cash flow to shareholders as dividends or buybacks.

The dividend change does “raise an eyebrow” for Joel Levington, managing director for corporate credit at Brookfield Investment Management Inc. in New York.

Cisco’s cash flow and cash balances are “largely tilted outside the U.S.,” which “limits financial flexibility, something unique for such a highly rated entity,” he said in an e-mail. Cisco can get away with it if it “will stop pursuing moderate-to-large acquisitions,” he said.

Including last month’s acquisition of NDS Group Ltd., which makes software that powers cable set-top boxes and delivers video, Cisco forecast profit of 45 cents to 47 cents a share this quarter, compared with the average estimate of 46 cents.Sales will rise 4 percent to 6 percent from a year earlier.

The company spent $375 million on business acquisitions in its latest fiscal year, up from $266 million the year before, according to an earnings statement.

With its free cash flow of $2.8 billion last quarter, Cisco can afford the dividend, and “this is part of the transition to a more mature company,” according to Jon Duensing, the Boulder, Colorado-based head of corporate credit at money manager Smith Breeden Associates, which oversees $6.3 billion and doesn’t reveal its positions.

“From a debtholder’s perspective, they currently have plenty of balance-sheet cushion,” he said in a telephone interview. “While it’s currently regarded as manageable, it’s likely this type of activity will continue to be a theme.”


For more on corporate dividends, see Slideshow: Spotlight on Dividends and Tax Hike Could Discourage Dividend Revival.


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