XLNX: Xilinx Joins the Dumb Financing Decision Parade

By William Trent, CFA of Stock Market Beat

For some reason, the latest fashion appears to be issuing convertible notes. The practice allows companies to reduce the apparent share count, but assuming the share price rises (which stockholders are presumably rooting for) the shares willl just come right back. We’ve seen this with Ceradyne (CRDN) and Finisar (FNSR), and now Xilinx prices $900 mln 3.125 pct convertible debentures | Reuters.com:

Xilinx Inc. (XLNX) said it priced $900 million of 3.125 percent convertible junior subordinated debentures due in 2037, and expects the sale to close March 5.The debentures will initially be convertible into shares of Xilinx’s common stock at a conversion rate of 32.0760 shares of common stock per $1,000 principal amount of debentures, the company said.

At recent share prices, the company should be able to buy back between 32 and 33 million shares with the proceeds. If the company does well and the shares rise above $31.18 before 2037, the company will then exchange the bonds for approximately 29 million shares. So, for a net reduction of 3-4 million shares the company will be paying a 1.725% premium (the convertible yield less the dividend yield on the stock) for 30 years.

The additional interest expense relative to the dividends that would otherwise be paid amounts to $15.5 million per year. That would allow the company to buy 600,000 shares annually at the current price, which would give them the same net share reduction after just 5 or 6 years rather than the 30 year term of the convertible bonds.

Or alternatively, the company could buy back shares with the $300 million it used in the December quarter to increase its balance of short term investments. That would allow them to buy back 11.5 million shares and retire them permanently, never having to worry about the dilution again, and never incurring the interest payments on the debt. Over time, that would quadruple the net share buyback and they would recover more than 100% of the initial outlay in interest savings over the life of the convertible. If, for some reason, the company then failed to generate sufficient cash flow to run its operations (which appears to be an unlikely outcome) they could always then turn to the convertible securities market for a cash injection.
Of course, the company won’t have to reissue the shares if the stock does not rise above $31.18 by 2037. But we’re pretty sure shareholders aren’t interested in that potential outcome. No matter how you slice it it is hard to see how this deal is positive for existing shareholders.

The author may hold a position in the securities discussed. The author’s current holdings are as follows: Long: Union Pacific (UNP) put options; Air Products (APD) put options; Bookham (BKHM; Ballard Power (BLDP); Syntax Brillian (BRLC); CMGI (CMGI); Genentech (DNA); Ion Media Networks (ION); Three Five Systems (TFS); IShares Japan (EWJ); StreetTracks Gold (GLD); Starbucks (SBUX); U.S. Oil Fund (USO); Plantronics (PLT) call options; Short: Landstar (LSTR) put options; Plantronics (PLT) put options

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