The little chip company that could

The quarterly report of everyone’s favorite chip company provides an opportunity for a Dividend Investor in a Stock Market to reflect on the current frisson from a safe distance. Recall that chip manufacturers are often “old tech”—meaning at least several decades old—and pay dividends. The age and the payments are related. The chip companies can trace their lineage back to the post-war decades when it was still sine qua non for successful companies to actually share their success with company owners. (A radical idea I know; don’t tell the kids.) This is in contrast to most software, internet, and social media companies that came of age in the dividend-light or dividend-free 1990s or later. From my perspective, the heritage goes back even further. Semiconductor manufacturing (if not design, in this case) is capital intensive, and such businesses have historically been expected to return a good share of the cash profits in return for the large outlays needed to capitalize their operations. Think 19th century railroads and 20th century industrial titans.

So where does the vanguard AI chip designer stand? The company’s pre-boom cashflow from operations has bounced around in recent years, coming in at ~$5-6 billion annually. For the year ending January 31, 2024, it registered $28 billion. Capex has been steady at just over $1 billion annually but will likely rise as the company fends off challengers. That still leaves $27 billion in FCF for the past year. Wall Street brokerages are expecting that number to rise sharply this year and beyond. Not bad.

What have they done with the windfall profits? The company initiated a dividend a decade ago, but has kept it flat for the past four years. The aggregate payout comes to $400 million per year. For their pre-boom years, that translated into a dividend payout ratio of 10-15% or so. For the past year, it’s been more like 1.3%. Yes, you read that correctly, a dividend payout of just over 1%.

What about buybacks? (Surely you’ve heard of them….?) The well-regarded management team has spent $9 billion repurchasing their shares each of the past two years. The share count has barely moved so the $9 billion annual figure is likely mostly just a form of compensation to employees. Still, that number is expected to move up sharply along with all the rest in the years to come. It might need to just to extinguish the share issuance to employees: $9 billion doesn’t get you what it used to when the company’s market capitalization is over $2 trillion.

The company is not a major acquirer, so cash has been building up on the balance sheet, with $26 billion there as of January 31, 2024. That’s 65 years of dividends or nearly 3 years worth of offsetting stock-based compensation. (That comp calculation is a lot more complex; I simplify grossly here.)

While the Stock Investor may not care much about this cash glut, the Dividend Investor sees this as a conundrum: what should the company do with their good fortune? It has come on so quickly, it’s possible the board and senior management are equally puzzled.

Do they use it to purchase other businesses? Large acquisitions rarely work out well and don’t seem to be part of this company’s ethos. Do they signal good times and higher share prices ahead (in theory) with the announcement of an enormous new buyback that goes beyond employee compensation? (They are finishing up a $25 billion buyback announced less than a year ago.) A $100 billion new buyback might compete with Apple’s ($110 b) and Google’s ($70b) for Wall Street’s attention.

Do they raise the dividend materially? Or is that still considered a sign of defeat rather than victory? With the recent announcements from Meta and Google, it would be less a Silicon Valley faux pas than it might have been in previous years.

They have not asked me, but if they did, I might suggest a large, special dividend. It would reward shareholders (as opposed to the share-sellers targeted by buybacks) with an actual cash return. And it would acknowledge that the company was at the right place at the right time, but not conflate good fortune with permanent dominance.

Wall Street would hate it of course. No fees, no transactions. And frankly, the current shareholders probably wouldn’t know what to do with the cash payment. So it won’t happen. But looked at strictly from a business perspective, for a company in a windfall-profits situation, with capital expenditures still modest, no major acquisitions on the horizon, and buybacks already at aggressive levels, the special dividend actually makes sense. At least to me.

This is why I don’t get invited to parties in Silicon Valley.