I. Capital Structure Choices
Table 16 TI’s Statement of Current and Long-term Liabilities
Accounts Payable
Accrued Expenses
Deferred Revenues
Other Current Liabilities
Total Current Liabilities
Total Long Term Debt
Table 17 TI’s Statement of Shareholder’s Equity
Shareholder's Equity
Deferred Income Tax
Minority Interest
Other Long Term Liabilities
Total Long Term Liabilities
Total Liabilities
Common Shares Outstanding
Preferred Stock
Common Stock, Net
Additional Paid-in Capital
Retained Earnings
Treasury Stock
Other Shareholder's Equity
Shareholder's Equity
Total Liabilities & Shareholder's Equity
Figure 6 TI’s Debt and Equity Structure, 2007 to 2011
A. Capital Resources
Texas Instrument’s liquidity comes from cash flows from operations. The company’s liquidity comes from ash and cash equivalents, short-term investments, and revolving credit facilities.
In 2011, the cash flow from operations dropped from $3.82 billion in 2010 to $3.26 billion due to lower net income. The amount of cash and cash equivalents held by the company during the same period was $992 million of cash and cash equivalents. Short-term investments as of December 31, 2011 was $1.94 billion.
TI has two revolving credit facilities that would allow them to borrow at variable interest rates, up to $920 million until August 2012, and up to $1 billion until July 2012. With respect to the market, Texas Instruments ranks on the 64th percentile (1026th of 2924) in terms of debt for all major listed companies, in the technology sector it ranks in the 51st percentile (254th of 526) and in the semiconductor industry, at the 38th percentile (8th of 13).
Figure 7 TI's Long-Term Debt Position
Table 18 TI's Long-Term Outstanding Debt (as of December 2011)
Notes due 2012 at 6.15% (assumed with National acquisition)
Floating-rate notes due 2013 (swapped to a 0.922% fixed rate)
Notes due 2013 at 0.875%
Notes due 2014 at 1.375%
Notes due 2015 at 3.95% (assumed with National acquisition)
Notes due 2016 at 2.375%
Notes due 2017 at 6.60% (assumed with National acquisition)
Add net unamortized premium (assumed with National acquisition)
Less current portion of long-term debt
(382
Total long-term debt
TI invested $5.43 billion primarily for the acquisition of National Semiconductor in 2011, while it used $199 million for acquisitions of wafer fabrication equipment in 2010. Capital expenditures were lower for 2011 at $816 million, which were primarily for assembly/test equipment and analog wafer manufacturing equipment, compared to the previous year’s capital expenditure of $1.20 billion.
Also for 2011, TI’s financing activities yielded a net cash of $2.59 that is almost the same as its previous year’s financing activities totaling to $2.63 billion. In 2011, TI borrowed a total of $3.50 billion, using a combination of fixed and variable-rate long-term debt and a net of $1 billion from the issuance of commercial paper. Debt was acquired for the purchase of National Semiconductor while commercial paper was issued for general corporate purposes.
Additionally, the company used $1.97 billion to repurchase 59 million shares of common stock in 2011. Dividends paid in the same year are $6434 million versus dividend payout of $592 million in 2010, reflecting a 31% increase in quarterly cash dividend rate.
Table 19 TI's Statement of Cash Flows, 2007 to 2011
Cash Flow - Operations
Net Income
Depreciation, Depletion, Amortization
Other Non-Cash Items
Total Non-Cash Items
Deferred Income Taxes
Total Changes in Assets/Liabilities
Other Operating Activities
Net Cash from Operating Activities
Cash Flow - Investing
Capital Expenditures
Acquisitions, Divestitures
Other Investing Activities
Cash Flow - Financing
Net Cash from Investing Activities
Debt Issued
Equity Issued
Dividends Paid
Other Financing Activities
Net Cash from Financing Activities
Foreign Exchange Effects
Net Change in Cash & Cash Equivalents
Cash at beginning of period
Cash at end of period
Texas Instruments have long-term contractual obligations, including debt servicing, operating lease obligations, software licenses, purchase obligations, and deferred compensation plans. Long-term debt obligations are for the principal loan payments (note that interest payments are not included in the presented number). Operating lease obligations are minimum payments for leased facilities and equipment. Software licenses are for the payment of electronic design automation software licenses. Purchase obligations are contractual arrangements with suppliers that involve fixed non-cancellable payment schedule or minimum payments due with a reduced delivery schedule.
Table 20 TI's List of Contractual Obligations
Long-term debt obligations
Operating lease obligations
Software license obligations
Purchase obligations
Deferred compensation plan
B. Capital Structure Conclusion
II. Optimal Capital Structure
Relative to the rest of the industry, Texas Instruments has very little debt. In fact, prior to debt financing a year ago, the company had no long-term liability. Its current liabilities are about a fourth of the capitalization of the company as shown below. This section discusses the effect of varying the company’s capital structure, in seeking optimal returns and value.
Figure 8 TI Capital Structure
A. Cost of Capital
TI’s cost of capital is calculated using the Weighted Average Cost of Capital (WACC) approach. The WACC is one of the most useful and fundamental concepts of corporate finance. TI’s WACC is calculated as follows:
Using information from TI’s published financial statements, we calculate the WACC as follows:
Element
WACC:
11.93%
Cost of Debt rD:
1.50%
Corporate Tax Rate TC:
27.19%
Total Debt D:
Total Equity E:
Total Firm Value V:
Cost of Equity rE:
12.84%
Using the calculation tool for optimal capital structure and the following inputs, we get the optimal capital structure for Texas Instruments.
Table 21 Input Values for Capital Structure Calculations
Table 22 Capital Structure Calculation Results
D/(D+E) Ratio =
Beta for the Stock =
Cost of Equity =
AT Interest Rate on Debt =
WACC
Implied Growth Rate =
Firm Value (no growth) =
Firm Value (Perpetual Growth) =
Value/share (No Growth) =
Value/share (Perpetual Growth) =
The calculations show that the optimal value for TI is to acquire a total debt amount of 60% of the total valuation of the company. Its cost of equity increases from 6.03% to 17.67% but the WACC decreases from 9.54% to 8.77%. Share prices for perpetual growth are $61.75. The implied growth rate herein is 2.25%.
The calculations show that the firm increases its value if it moves into an optimal capital structure. Debt financing is always cheaper than equity financing, and TI will be better off it is finances its future growth using debt.
Note that in this case, debt is issued through commercial paper (bonds), the ratings of which decline as the debt financing increases. At the optimum debt contribution value of 60%, TI’s bonds would be rated A-, still a very good rating for the company’s bonds, since the current rating of the company’s commercial paper is A+. I believe that TI should maintain an A bond rating (A+ or A- at the very least) so the optimal capital structure will be acceptable. The calculated WACC becomes 8.98% and the firm value is optimized.
Based on this analysis, the company has too little debt. In fact, the debt ranking of TI is unbelievably low. It is a company that is awash-with-cash and is using its cash for operations and investments. A company with such resource would definitely have good growth prospects that could be enhanced using debt financing.
Debt Ratio
Beta
Cost of Equity
Bond Rating
Interest rate on debt
Tax Rate
Cost of Debt (after-tax)
WACC
Firm Value (G)
AAA
INR 5,848
AAA
INR 6,029
AAA
INR 6,221
AAA
INR 6,426
AA
INR 6,496
A
INR 6,496
A-
INR 6,496
CCC
INR 6,496
CCC
INR 6,496
CCC
INR 6,496
Table 23 Varying The Capital Structure of Texas Instruments
Figure 9 TI Cost of Equity and Beta: Debt Ratio
Table 24 TI's Long Term Debt Ranking
6th percentile
4376 of 4675
Sector
3rd percentile
839 of 872 in Technology
Sector
++
7th percentile
25 of 27 in Semiconductor - Broad Line
III. Dividend Policy: The Trade Off
INR 6,496
++++++++*++
Texas Instruments have paid out dividends to its shareholders without interruptions since 1962. Originally, the dividend rate for TI was at $0.085 per share annually. Eventually and as the company grew its portfolio into higher yielding and more profitable business segments, it has increased its returns to shareholders, at about six times (6x) over the last six years and a half. In 2011, the dividends paid out were again raised by 31%, which is the ninth increase in dividend rates in the last eight years. The current dividend payout per share is $0.68 annually.
INR 6,496
+++++++++
INR 6,496
+++++++++*+++++++++
Figure 11 TI Total Dividend Payout Per Year
Texas Instrument’s dividend yield is also examined. The dividend yield, expressed as a percentage, is the sum company's total annual dividends per share divided by its current price per share. Companies with high dividend yields assure investors of relatively stable cash flows. However, some companies have used dividend yield to portray stability despite having financial trouble. As of March 2012, the dividend yield of Texas Instruments is 1.79%.
INR 6,496
++++++++++
INR 6,496
+
B. Stock Repurchase Program
Texas instruments have incentivized their employees through stock options. When these options are exercised (sold to the market), an ownership dilution is expected. To counter-act this, Texas Instrument has installed a stock repurchase program to neutralize the potential dilutive effect exercising employee stock options. However, in 2004 the company implemented a more aggressive stock repurchase plan. This was hatched to reduce the number of outstanding share. The effect of reducing outstanding shares is a reduction in the cash required for dividend payouts. That cash can be used for other activities on the company and in the late 2004, TI generated more cash for its operations.
Moreover, Texas Instruments’ recent activities will have an effect on the stock repurchase program the company has implemented. With the purchase of National Semiconductors, TI has drawn from its credit facilities, term loans that must be serviced over several years. The servicing of debt comes from net cash flows of the company and to manage the cash flows, the repurchase of stock would be reduced to low levels. This would be a significant tactical change since the company has reduced the number of outstanding stock by 34% from its 2004 levels. From 2004 onwards, the company has spent $27.5 billion in stock repurchase.
INR 6,496
+++++++++++
Sector
++
Texas instrument ranks in the 75th percentile overall listed companies (1146th of 4656), ranks 113th of 856 in its sector (86th percentile) and the 7th best dividend policy in the semiconductor industry (74th percentile, 7th of 27).
IV. Dividend Policy: A Framework
INR 6,496
++++++++++++*+++++
Texas Instruments generates enough cash that could be distributed to its security holders. Security holders, in this case are the debtors of Texas Instruments, equity shareholders, preferred equity shareholders, and convertible security shareholders. Free cash is used to pay dividends or make acquisitions or develop new products or invests in new capital assets, or reduce debt and pay interests. Free Cash Flow to Equity is calculated as:
FCFE = Net Income - Net Capital Expenditure - Change in Net Working Capital
+ New Debt - Debt Repayment
Recently, FCFE has been used to analyze the value of a company. The historical FCFE of Texas Instruments is shown below.
INR 6,496
+++++++++++++
INR 6,496
+++
Figure 15 TI Historical Free Cash to Equity Trailing Twelve Month (TTM) Average
Overall, TI belongs to the 94th highest percentile in terms of FCFE (220th of 4353), in the technology sector it belongs to the 94th highest percentile (46th of 798) and is number one in the semiconductor industry (1st of 24, 95th percentile).
In terms of FCFE rankings in Trailing Twelve Month (TTM) average, Texas Instruments ranks 132nd of 4138 overall (96th percentile), 24th of 730 in the technology sector (96th percentile), and 2nd in 24 companies in the semiconductor industry (91st percentile).
INR 6,496
++++++++++++++*+
The cash flows to equity are a direct result of management investments. The result of management action is summarized as Returns on Equity and Returns on Assets. TI’s current ROE is 16.88% while its ROA is 10.2%. TI ranks 905th of 4055 overall (77th percentile) in terms of ROE, 158th of 754 (79th percentile) in the technology sector, and is the 5th of 22 (77th percentile) in the semiconductor industry. In terms of ROA, the firm ranks 66th of 4163 overall (83rd percentile), 147th of 766 (81st percentile) in the technology sector, and is the 6th of 23 (73rd percentile) in the semiconductor industry.
INR 6,496
+++++++++++++++*++++
Figure 17 TI Return on Assets
Texas Instruments is a profitable company but how well does it performs against other corporations. The graph below shows TI’s total shareholder return with the S&P 500 Index and the S&P Information Technology Index over a 5-year period, from December 31, 2006 to December 31, 2011. Comparative investment analysis between TI, the S&P500 Index and the S&P Information Technology Index shows the current value of a hypothetical $100 investment in each, at the beginning of the period in TI common stocks. If we invested $100 in TI in December 2006, the value of that will now be $110. In fact, TI outperformed the S&P500 within the same period by 11%. However, the S&P500 technology index outperformed TI stocks by 10%.
INR 6,496
++++++++++++++++
INR 6,496
+++++++++++++++
Texas Instrument’s managers are effective. The return on both equity and assets are of high quality, compared to overall market, its sector and its particular industry. The company is performing well with respect to other similar companies, as shown in the comparison of cumulative returns versus the S&P indices. It would be prudent to trust TI’s managers.
C. Dividend Policy Conclusion
Why fix what is not broken? Texas Instrument’s dividend policy and stock repurchase policy are both effective and efficient and is the stuff in textbooks. I could not recommend any changes other than to revert to an aggressive stock repurchase plan when the long-term debt obligations are addressed.
V. Valuation
The current valuation of Texas Instruments is described in the financial metrics shown below. The figures indicate a very healthy firm, a potentially solid investment.
INR 6,496
+++++++++++++++++*++++++++++++
Enterprise value of $37.14 billion
Price Earnings (PE) ratio of 18.67
Share Price to Sales Ratio of 2.455
Share Price to Book Value of 2.985
Dividend yield is 2.40%
Gross profit margin is 49% and net profit margin is 8.9%
Return on equity is 16.88% and return on assets is 10%
Current ratio is 2.61
We should put these numbers in proper context by comparing Texas Instruments with other similarly sized technology players in the semiconductor industry. TI ranks fourth in terms of returns (compared with the three other companies).
Table 21 Texas Instruments Comparative Performance
The final evaluation of a company’s worth is an evaluation of its value. To calculate the value of Texas Instruments, we use segment valuation by examining cash flows and company growth prospects and then determine firm value.
INR 6,496
++++++++++++*+++++
The Free Cash Flow to Equity (FCFE) is used to determine the value of the Texas Instruments. The historical FCFE using published data is shown below.
Table 22 TI Historical FCFE Calculations
INR 6,496
+
Non-cash Charges
Change in Operating Capital
Less: PPE
Less: Long term Debt Payments
Free Cash Flow to Equity
The growth rate of FCFE is calculated as follows:
Table 23 FCFE Growth Rate Calculation
Total Assets
Stockholders Equity
Retention Rate
Profit Margin
Asset Turnover
Financial Leverage
Growth Rate of FCFE
Lastly, the Price per share to FCFE ratio is calculated. The calculations show that Texas Instrument’s stock is not undervalued compared to the rest of the semiconductor industry and has in-fact outperformed the industry.
Table 24 Valuation of TI's share through Price/FCFE Ratio
INR 6,496
++++++++
Semiconductor Industry
Shares
1,172,051,474.00
INR 6,496
+++++++++++++++
2,621 M
FCFE/Share
2.24
INR 6,496
++++++++++
Price/FCFE
Table 25 Historical Performance of TI Vs. Industry
Texas Instruments
Industry
Outperform or Undervalued?
B.
Valuation of Texas Instruments
We use the present value of the FCFE to calculate the value of TI’s stock. To do so, we calculate the following:
INR 6,496
+++++++++++++++++++++++
INR 6,496
++++
Growth rate – calculated by multiplying the retention rate, profit margin, leverage and asset turnover of TI
Weighted average cost of capital
The FCFE is projected by taking the previous FCFE and multiplying by the projected growth rate. The terminal value is also calculated.
INR 6,496
++++++++++++++++++++++++
INR 6,496
++++++++++++++++++++++++*+++++
The present value of the FCFE is divided by the number of outstanding shares and compared with current price of TI’s stock.
INR 6,496
++
WACC
13.33%
INR 6,496
+++++
Present Value FCFE
40,542.51
INR 6,496
+++++++++++++++
34.59
INR 6,496
++++++++++
This shows that the value of TI’s stock is currently undervalued in the market. The projected value of TI’s cash flows translates to a stock price of $34.59 per share. It would be a good idea to buy TI stock today and anticipate appreciation of price, given the projected cash flows from the company’s activity.
This valuation methodology is appropriate because of the expected cash flows form TI’s products, which are essentially commoditized. With firm operating principles and responsible use of financing, Texas Instrument is poised to continue outperforming the market and continue leading in terms of performance, in the semiconductor industry.
