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SUMMARY
Parkev Tatevosian, CFA, analyzes AMD's decision to raise up to $5 billion through investment grade bonds despite robust profitability. The discussion centers on capital structure optimization, cost of capital, and the financial rationale behind leveraging debt even when cash flows are strong.
MAIN POINTS
- AMD announces plans to raise up to $5 billion in investment grade bonds, potentially its largest bond sale.
- The company may use bond proceeds for general expenses and to refinance $875 million in bonds maturing soon.
- An explanation of the cost of equity and how retained earnings represent a cost to shareholders.
- AMD's after-tax cost of debt is estimated at 5.75%, significantly lower than its 16.3% cost of equity.
- Future cash flow projections are discounted using the weighted average cost of capital to determine present value.
- The rationale for borrowing despite strong cash reserves is to optimize capital structure and lower the cost of capital.
DETAILED ANALYSIS
AMD is preparing to raise as much as $5 billion through an investment grade bond sale, which would be the largest in the company's history. The final size of the offering may be adjusted based on market demand, reflecting the current high appetite for corporate bonds, particularly those associated with artificial intelligence. Despite the sizable figure, the new debt is modest relative to AMD's $800 billion market capitalization and expected cash flows exceeding $75 billion over the next three years.
The company intends to use the proceeds for general corporate purposes, including the potential refinancing of $875 million in bonds maturing in the near term.
The analysis delves into the financial logic behind AMD's move, emphasizing the difference between the cost of equity and the cost of debt. Using the capital asset pricing model, AMD's cost of equity is calculated at 16.3%, factoring in the risk-free rate, company beta, and market risk premium. In contrast, the after-tax cost of debt is estimated at 5.75%, making debt a significantly cheaper source of capital.
By borrowing at lower rates, AMD can use internally generated cash flow for shareholder returns such as dividends or share buybacks, thereby rebalancing its capital structure toward debt and reducing its weighted average cost of capital (WACC), which stands at 13.66%.
Lowering the WACC has a direct impact on the company's valuation, as future free cash flows are discounted at a lower rate, increasing their present value. For example, an estimated $43 billion in free cash flow in 2030 is valued at $22.6 billion in today's terms when discounted appropriately. This strategic use of debt, even when not strictly necessary, is a common practice among corporations seeking to maximize shareholder value by optimizing their capital structure and minimizing overall financing costs.
LINKS
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- Parkev Tatevosian's book on a six-step investing framework.
- Discounted access to Fiscal.ai for investment research.
- Webull sign-up link with bonus shares offer.
- Subscribe to Parkev Tatevosian's free monthly Substack newsletter.