Monday, February 9, 2009

Cisco taps the credit market

Today Cisco Systems borrowed $4 billion in a combination of 10 and 30 year maturities.  The issue was reported to be very well received by investors.  Interesting, because the company has a very strong balance sheet with $29 billion of cash and equivalents and only $6 billion in debt.  (note for nitpickers:  most of their cash is held outside the U.S., which creates tax issues, and $500mm of their debt matures later this month.)  Nonetheless, unlike many corporations, they had plenty of options besides today's offering.

So what does this mean?  It tells me two things:

This is an interest rate call.  The decision by CSCO to issue debt today, at these levels (4.95% for 10 years and 5.90% for 30 years) represents their opinion that present rates are attractively low and not likely to remain here or go significantly lower.  That's important because, unlike economists and strategists who freely and frequently offer predictions (see the semi-annual WSJ tables for the dismal record of the consensus), John Chambers & Co. have a significant economic stake in their decision:  they will either save or waste millions in interest payments over the life of the bonds.  

Some of the most bearish economists and strategists (who, it must be said, have made the most accurate economic forecasts since the onset of the current malaise) foresee continued and deepening recessionary forces and lower interest rates.  But while Chambers probably doesn't spend much time with demand curves or productivity functions, he is in a nearly unique position to view the global economy due to CSCO's vast global reach.  Doug MacKay at Broadleaf Partners LLC, a longtime CSCO follower, calls Chambers "the accidental economist from Main Street."

And higher interest rates are good.  They're good because they're usually a sign of improving economic activity.  They give banks and the Fed more room to maneuver.  With a bit of inflation, homeowners should see the value of their homes increase and be able to repay their mortgages with cheaper dollars.  In the oft-cited case of Japan and the "lost decade", that country was unable to engender inflation and suffered through years of economic weakness.  Up to a point, higher rates would be good for the stock market.  Of course, we could have too much of a good thing, but that's another topic for another time.

The Strong Get Stronger  Along with the interest rate call, this bond issuance is a sign of how much of an advantage strong companies have over competitors in a poor economy.  While CSCO easily sold this bond issue, most of their competitors would find it difficult or impossible to borrow even at much higher rates.  It's a huge advantage.  They can aggressively attack while others can only defend.  Customers will be more willing to make long-term commitments with vendors whose future is secure.  And CSCO's  financial flexibility gives it a tremendous opportunity to make acquisitions and other investments at very attractive prices.  This advantage of size and strength is common to the highest quality companies in most industries.

To review my investment philosophy, I believe that high quality, franchise companies are extremely attractively valued at present.  While I can't predict the near-term direction of the market, I think that dominant blue chips with bulletproof balance sheets and dominant market positions that have lost a third to a half or more of their market caps in the past six months will likely double or triple in the next three years or so.  Many pay unbelievable dividends (INTC at around 4%?).   Please see my prior posts including 12/1/08 for more details.  My current portfolio includes ABB, BA, CAT, CSCO, DD, GE, GOOG, GS, INTC, SLB, and SYY.  (I've also got some NYT, a special case which will be covered in a future post).  I have a number of stocks on my watch list waiting for the right entry price.  I'll probably miss most of them.

Portfolio Update  

I did add to GE position today, but it's still relatively small.  Decided not to sell the GOOG calls; as they say in the option markets, three things can happen to overwriters and two of them are bad.  

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