- AMD plans to raise $600 million worth of equity and $450 million worth of convertible debt to partly pay off existing debt.
- The move will hurt investors in the short to medium term, but makes sense in the long term.
- After all, equity dilution is a better deal than bankruptcy for AMD investors.
Shares of Sunnyvale, California-based Advanced Micro Devices Inc. (NASDAQ:AMD) got battered in yesterday's trade, falling nearly 7%. The culprit was a recent announcement of AMD's intent to issue $600 million worth of common stock and $450 million worth of convertible debt to pay off some of its existing debt. While the move, which has incurred the wrath of the markets, will hurt investors in the short to medium term, it appears to make sense in the long term. After all, equity dilution is a better deal than bankruptcy for AMD investors.
First, the bad part
AMD's move to issue $600 million worth of common stock will dilute equity investors' claims on earnings per share (if it stays positive) and residual value upon liquidation (if it happens) of the company. Given the amount AMD plans to raise in equity, and the last traded price of its shares at $6.84 a piece, the implied equity dilution stands at about 110 million shares, or ~11%.
Also Read: Our updated analysis - Why AMD Inc Stock Should Stop Falling Now
The AMD stock has already fallen by nearly 7%, and it could fall further based purely on the mathematical implication of AMD's announcement. However, while the move will hurt investors in the near to medium term, it makes sense in the long term.
Now, for the good part
Part Payment Of Debt A Huge Relief
AMD plans to use the funds it raises to partly pay off its existing debt, which is a great move in the context of its longer term outlook. AMD has $226 million in short-term debt, which it reportedly intends to pay-off first, and a little over $2 billion in long-term debt. Now since AMD's long-term debt carries higher coupon rates (6.75%-7.75%) compared to those currently prevailing in the market, it's likely that the company will have to pay a premium to pay-off this debt.
Even if you assume a 5% premium on all of the long-term debt repaid, which is a hit (additional cost) in the short term, the good part is that AMD will have retired a sizeable chunk of its long-term debt.
|Amount ($ millions)|
|Funds To Be Raised||1020|
|To Be Paid Off First - Short Term Debt||226 (a)|
|Funds Available To Pay Off Long Term Debt||794|
|Funds Used Up By 5% Premium||38|
|Long Term Debt Repaid||756 (b)|
|Total Debt Repaid (short+long term)||982 (a+b)|
|% Of Current Debt Repaid||44%|
The fact that AMD will cut its debt by over 40% is a big deal because the company's value of shareholders equity is negative. While we normally use the debt/equity ratio to evaluate a company's financial leverage, in this case, the situation is not just dangerous, but dire, which brings us to the next point.
Does Equity Dilution Really Matter Here?
So, in theory, AMD's decision to issue common stock to raise funds dilutes equity investors' stake in the company, their earnings per share and thereby the value of their shares. But we're talking about a company that's piled up over $7 billion in losses. What's more, the value of AMD's shareholders equity is negative. What this means is that, in the event that the company gets liquidated as of today, shareholders will be left with no residual value after all assets have been sold and lenders repaid. As an investor, that's not a situation you want to get into.
As a matter of fact, AMD's move to raise equity funding actually gives shareholders a residual claim. AMD's current value of shareholders equity stands at -413 million USD. An infusion of $600 million worth of equity would bring that back into the green, to the extent of $187 million. For whatever it's worth, investors are still better off than before. And if AMD can continue to churn out profits in the coming quarters like it did in Q2 2016, that should set the boat sailing.
A Lower Bankruptcy Risk
The Altman Z-Score is a credit-strength test that's designed to evaluate the likelihood of bankruptcy for a publicly traded company. The test considers several ratios and assigns weights to each of them to arrive at a final score. A score below 1.8 indicates an elevated level of risk and implies that the company could go bankrupt, while a score of 3 or above puts the company in a safe zone.
The Altman Z-score for AMD currently stands at -1.02, which highlights the fact that investors currently run a huge risk by investing in AMD. In such a scenario, any form of financial restructuring which reduces AMD's debt would come as a relief. Even if everything goes as planned, and AMD pays off $982 million worth of debt, as of today, its Altman Z-score would only improve to -0.72. But some improvement is better than none.
Summing It Up
AMD shares could continue their downward journey even after yesterday's near 7% fall. AMD's decision to raise $600 million worth of equity and $450 million worth of convertible debt to partly pay-off its debt appears to be a good move. While AMD's proposed issue of common stock will hurt investors in the short to medium term, the move makes sense in the context of AMD's long-term outlook. After all, equity dilution is a better deal than bankruptcy for AMD shareholders.
Even though AMD is one of the best performing stocks in its sector having returned over 275% in the last twelve months, the stock is a high-risk investment option and is best left to highly speculative investors.