News Analysis date published New: 
Friday, September 17, 2010 - 16:52
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Friday, September 17, 2010 - 16:27
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Friday, September 17, 2010 - 16:52

This Sector's Mountain of Cash Could Soon Line Your Pocket

Friday, September 17, 2010 4:52 PM

Texas Instruments (NYSE: TXN) just got with the program. The company announced Friday morning that it will increase its existing stock buyback program by $7.5 billion and modestly boost its dividend.

Suddenly, using hefty cash balances to buy back stock or boost dividends is all the rage in the sector, and the chip giant wants in on the action. I took a look at this trend last week and since it shows no signs of abating, it's time to look at all the cash-rich tech companies to see how a stock buyback or a dividend move would impact their stock. [See: Why the Cheap Debt Frenzy is Great for Stocks]

I ran a screen to find the largest tech stocks that have at least $1 billion in net cash. I then also looked at their cash flow levels, and by combining cash and cash flow, looked to see how much they represented as a percentage of a company's market value. (Did you know that nearly half of Yahoo!'s (Nasdaq: YHOO) market value is accounted for in cash and cash flow?)

By using this as a yardstick, companies could theoretically reduce their share count by that percentage. For example, eBay (Nasdaq: EBAY) could afford to buy back 31% of its stock, and then simply let the cash balance rebound as future cash flow pours in.

Lastly, I was curious about potential dividend yields. In the past, tech companies usually loathed dividends because they were a sign that management no longer had compelling uses for the company's cash, which meant that growth opportunities were lacking. By now, we all know that the days of high-growth have ended (except for Apple (Nasdaq: AAPL), Google (Nasdaq: GOOG) and a few others).

A few companies offer paltry dividends with meager yields (except for Intel's more impressive 3.4% payout), but all of these companies could offer fairly hefty dividends simply based on cash flow and leave their hefty cash balances intact. Symantec (Nasdaq: SYMC), Dell (Nasdaq: DELL) and Hewlett-Packard (NYSE: HPQ) could offer dividend yields in excess of 8%. More likely, these companies would seek to have lower payout ratios, so I looked at what kind of dividends could be offered up if these companies paid out 60% of their annual cash flow in dividends. For most of these companies, that would translate into a dividend yield in the 4% to 5% range. Not bad, but not overly impressive either.

With coming tax changes that hike the capital gains rate on dividends, companies may look to go the buyback route instead. [Read: What Could Happen to Your Favorite Income Spots]

Looking at the column "cash flow as % of market cap," these companies could look to use all of their cash flow to buy back stock, leave the cash balance intact, and in the cases of Dell, HP and several others, could reduce the share count by more than 10% annually. That's just what HP is doing with its recently-announced $10 billion buyback. Microsoft (Nasdaq: MSFT) is rumored to have similar plans afoot.

What are the implications of a 10% annual share buyback? Well, at a minimum, it boosts earnings per share (EPS) by a commensurate amount. So a company that is only growing profits by +5% would see per share profits grow by +15%.

Action to Take --> Although firms like Dell and Yahoo have ample financial firepower relative to their market value, I'm especially intrigued by Symantec, which is now the largest standalone software security vendor, now that Intel has agreed to acquire McAfee (NYSE: MFE). The company also possesses a hefty data storage division, thanks to a 2005 acquisition of Veritas.

Symantec's shares now trade for half the value that they traded when that deal was announced, because the company has never been able to derive major synergies from the two divisions. But on a standalone basis, each of these businesses would hold real value to a suitor, and Symantec should look to shed one and focus on the other. Analysts seem to focus on a potential full buyout of the company. Jefferies thinks shares would fetch $19 or $20 if that happens, while UBS recently boosted its rating on Symantec to "buy" with a price target of $20 under the assumption that Symantec is "in play." But I think a sale of one part of the business if more likely.

Even without any moves, Symantec is still quite undervalued, trading at 10 times next year's profits, and management should seize on that. It could buy back nearly 15% of its stock every year simply out of cash flow. Sales growth is expected to be flat in the current fiscal year, but based on very recent trends, are expected to rise more than +5% next year. That should fuel slightly higher bottom-line growth, and when coupled with a large buyback, could again make Symantec a real EPS growth story.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.