Risks Rise as KLA-Tencor Pursues Leveraged Recapitalization

A few features of this leveraged recapitalization are a special cash dividend of $16.50 per share, representing 23% of the company’s stock price as of October 22, 2014, or approximately $2.75 billion. The board of directors intends that the dividend would be payable before December 31, 2014.

In connection with this the stock repurchase program, the company has approved an additional 3.6 million shares worth, which is valued at roughly $250 million, based on the closing price from October 20. This would be in addition to KLA’s previously announced $1 billion repurchase plan from July.

The total amount of capital that is being directed at the stockholders through these plans would be an aggregate of approximately $4 billion. Apparently, that was enough to trigger downgrades as B. Riley lowered the rating to Neutral from Buy and Credit Suisse lowered its rating to Neutral from Outperform.

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Some investors might have concerns with the tactic of leveraged recapitalization. The initial special dividend might appear appealing at first, but what exactly is the company saying by instating it? Arguably KLA may be hinting that shareholders can better allocate that capital than the company can.

Companies that take on a fair amount of debt, generally speaking, often don’t ever really pay it off and instead drag it out over time. In the case of KLA-Tencor, the $2.75 billion would be almost a quarter of its market cap as of Thursday’s close.

You could even argue that KLA-Tencor’s board and management decided to be their own activist investors.

Obviously there is at least some inherent risk in this deal, especially when borrowing money is involved, even more so when it is being leveraged to buy stock and send a big chunk of capital out the door in a dividend. The company is trying to mitigate some of this risk of stock turnover in the near future by instating a special dividend. In some cases, borrowing money to pay a big dividend and fund a buyback can be called robbing Peter to pay Paul.

Rick Wallace, president and CEO, said:

These factors, coupled with a strong balance sheet and the Company’s ongoing focus on cash distributions, will enable our stockholders to continue to benefit from KLA-Tencor’s sustained success in the marketplace. This is another major step forward for the Company in executing our capital allocation strategies in support of our strategic objectives, while increasing returns to stockholders.

The stock has a consensus analyst target price of $75.00 and a 52-week trading range of $59.44 to $81.27. The company has a market cap of over $11 billion.

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