It’s been several days since speculation surfaced that Advanced Micro Devices (NASDAQ:AMD) was in advanced negotiations to buy Xilinx (NASDAQ:XLNX) for $30 billion. If successful, should the company pay for the acquisition with AMD stock, cash, or a combination of both?
My recommendation would be to use AMD stock entirely to pay for the deal. Here’s why.
If You Pay for Xilinx With Cash
AMD had $894 million in total debt at the end of June and $1.78 billion in cash and cash equivalents for a net cash position of $881 million. Xilinx had $1.0 billion in net cash as of Q1 2021.
Assuming the $30 billion figure is the market capitalization AMD pays (4% premium to current prices as I write this) for Xilinx, the enterprise value would be $29 billion. That’s about 30% of AMD’s current enterprise value of $98 billion.
No matter the benefits, and there appear to be plenty, that’s a significant investment for any company, but especially so for AMD, that’s only now starting to generate decent free cash flow–$610 million in the trailing 12 months.
If it takes all of its cash and all of Xilinx’s to pay for the deal ($4.8 billion), that leaves it with approximately $25 billion in debt it will have to borrow to complete the transaction. Based on 2% interest, AMD’s would increase by $500 million annually.
The two companies currently have a combined free cash flow of $1.63 billion, so there’s plenty in the kitty to keep the bankers happy. I’m not sure of the synergies and cost savings, but there’s bound to be some, so let’s add $200 million to its free cash flow.
After deducting the added interest expense, it will have $1.3 billion in free cash flow to continue to grow the combined business.
It’s safe to say, five years down the road, the free cash flow generation will be so strong, diluting shareholders at this point makes little sense. AMD can definitely afford the acquisition.
It Should Pay for Xilinx With AMD Stock
I’m bullish on chief executive officer Lisa Su and Advanced Micro Devices. As I’ve noted several times in the past couple of years, she’s one of the best CEOs in America and worth every penny of her $58.5 million in 2019 total compensation.
Over the past five years, AMD stock has gained approximately 4,200% through Oct. 15. If you were along for the ride, I would congratulate you on your massive unrealized gains. Year to date, AMD is up 84%, or about eight times the U.S. markets as a whole.
In August, I suggested that if you bought at $81. It wouldn’t be an expensive entry point if you held for a significant period of time–say, three to five years. However, if you had a shorter time frame, I thought you could get it cheaper.
Getting Xilinx to Sell
Sure enough, you could. It fell into the low $70s in late September but has since recovered. There’s been plenty written about tech stocks getting hit with a Biden election victory. I don’t think anyone knows how the markets will react. I’ll be happy a certain someone is moving out of the White House. But I digress.
What I’m trying to say is that AMD stock, by almost every valuation metric is historically very expensive at this point. I’m sure if Henry Singleton were alive, a champion allocator of capital, he’d be totally for buying Xilinx with the company’s stock.
And I’m not the only one who feels this way.
InvestorPlace’s Mark Hake recently discussed this very subject.
“The fact is anytime you have a high P/E stock and use it to acquire another company with a lower P/E ratio, the combined company will have a lower P/E. That is, the combined earnings will lower the overall P/E ratio compared to the original P/E ratio of the acquiring company,” Hake wrote on Oct. 15.
“Many tech companies know this. That is why they try to use their stock as a currency. As a result, despite the dilution, the stock of the acquiring company will still rise.”
I couldn’t have said it any better myself. However, as Mark points out, the bigger issue is getting Xilinx to sell. The premium can be worked out, but you’re out of luck if the seller won’t sell.
The Bottom Line
I definitely believe that if AMD is successful, at least 50% of the deal should be paid for with stock.
To not take advantage of the 4,200% rise in the value of its share price over the past five years to make what is possibly a transformative deal for the company merely because interest rates are historically low is short-sighted, in my opinion.
Who knows when AMD’s stock will be this valuable again as M&A currency?
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
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