Cisco Systems, Inc. (NASDAQ: CSCO) is beginning to in some ways feel like the lost leader… a silver-back gorilla with poor eyesight if you will.  The company has incredibly high gross margins and has now gone into just about every aspect of the network that now includes the data-center.  The company already had some $40.2 billion in cash and equivalents at the end of last quarter.  So why on earth is the company out leveraging itself a little bit more by raising $4 billion more in a debt offering?

What is interesting is that the world around Cisco is changing at the same time that it is trying to evolve into a networking and data-center giant.  Cisco used to be partners with Hewlett-Packard Co. (NYSE: HPQ) and now it seems as though Alcatel-Lucent (NYSE: ALU) is almost magically regaining a decade or so of lost opportunity.  Juniper Networks, Inc. (NASDAQ: JNPR) keeps hanging in there as well in the competitive landscape.

Wednesday evening came the pricing of a $4 billion debt offering in a three-series round of senior unsecured notes from Cisco:

• $2.0 billion will mature in March 2014 with a 1.625% rate,
• $1.25 billion will mature in March 2014 at LIBOR+25 basis-points,
• and $750 million will mature in March 2017 with a 3.150% rate.

As far as the overall financial needs, this is where the question is.  Frankly, any corporate manager out there that thinks there may be a remote need of capital should grab this from the market if they can secure the borrowings at such a low rate.  Our issue is that Cisco has steadily been ratcheting up its long-term debt from $6.4 billion in mid-2008 to almost $12.2 billion in mid-2010.

Cisco intends to use the net proceeds from this offering for general corporate purposes.  The problem is that general corporate purposes may just be a continuation of Cisco’s wasteful share buyback plan.  The company keeps promising to pay a dividend, but the consensus seems to be that it will only be about 1.5%.  The buybacks have not worked and it is amazing that a group of investors have not banded together and tried to force John Chambers from merely offsetting the dilution from all of his stock options and from all of the smaller companies he has acquired.  There has yet to be a single shred of credible evidence that John Chambers’ endless share buybacks have really done a single thing to support the stock.

To be fair it also has to be pointed out that much of Cisco’s cash stash is actually still held in overseas lands where the sales took place from local units.  Until a broad overseas capital repatriation moratorium effort is proposed by Washington D.C. to spur growth in America, it may just be that Cisco needs more local domiciled capital.  There is also nothing wrong with the rates that Cisco is borrowing money at as the rates are extremely low.  Even if this debt gets used to just pay down other maturing debt it is not as clean of a use of capital as the company could be.  Cisco should arguably carry almost no debt.  Its market capitalization of $100 billion is far too high to ever be acquired and the company has not exactly gone out and made a mega-acquisition.

For whatever this is worth, S&P gave an “A+” rating to the notes.  S&P noted that the rating reflects the company’s strong leadership position and an exceptional liquidity profile.  S&P expects Cisco to keep a minimal financial risk profile while balancing shareholder returns and growth objectives. The rating also expects that Cisco will maintain a net cash position “post repatriation taxes less funded debt” in the $10 billion to $15 billion range over time.

Cisco’s management may want to at least consider stepping up some general oversight efforts here.  Continuing on the same capital structure path of 2001 in 2011 is not working and these guys should be mature enough to recognize it.  We are admittedly much more critical of Chambers and the company than the ratings agency call noted above.  The reason is evident as to why, that being a stock that pays nothing and has generated nothing for shareholders in more than a decade despite massive underlying growth.

JON C. OGG

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