Symantec (NASDAQ:SYMC) ended up over 5% on news of a transformative deal to purchase Blue Coat (Private:BLCT) for $4.65 billion in cash. The deal is highly accretive to earnings due to striping out costs, but the question remains whether the move will invigorate growth that will push the stock out of several years of doldrums.
The purchase helps Symantec move into a leadership position in cloud security with enterprises, but the revenue base is still over 80% focused on legacy revenues that includes consumer revenues. The deal highlights the biggest concern that the business from Symantec is even weaker than the forecast for the slightly negative revenue growth this year.
The deal is highly accretive primarily from the better allocation of the cash now sitting on the balance sheet after collecting the proceeds from the Veritas sale. Symantec ended the March quarter with nearly $6.0 billion in cash sitting around on the balance sheet of a stock worth now slightly above $11.2 billion.
The deal involves the issuance of $2.8 billion in new debt and paying the remaining balance of $1.85 billion from cash on the balance sheet. Along with spending another $1.3 billion on capital return programs for FY17, the cash balance will drop below $3.0 billion. The new debt places the long-term debt position at roughly $5.0 billion for a net debt position after closing the purchase of Blue Coat.
The valuation potential ultimately comes down to a connection of the new FY18 EPS guidance and the ability to grow the business. The new Symantec guided toward an EPS of $1.70 to $1.80 for the first fiscal year after closing the deal. The new number is far above the current expectations of $1.39 for the stand alone Symantec.
The prime reason for the large EPS increase is the striping out of $150 million in expenses from a Blue Coat business that had $163 million in operating income for the last fiscal year ended in April.
Combining those cost reductions with the $400 million cost reductions ongoing at Symantec and the profit story improves dramatically. On top of that, the reduction in the share count to 558 million shares to end FY17 next March provides an extra boost. The combined cost reductions of $550 million alone add an incredible $1 to EPS estimates. The addition of nearly $3 billion in debt pairs back the total benefit.
One quick earnings boost will come from debt reduction. Symantec pays $19 million per quarter in interest now and the higher debt will easily place that number closer to $50 million. The company could quickly add anywhere from $0.10 to $0.20 to the EPS total by paying down the debt via free cash flows over the next couple of years.
The market though is littered with tech stocks trading at roughly 10x forward EPS estimates due to limited revenue growth. Closing above $18 places Symantec at that forward P/E multiple. Apple (NASDAQ:AAPL), Qualcomm (NASDAQ:QCOM) and NetApp (NASDAQ:NTAP) all trade within the range of Symantec.
Now if the company can garner revenue growth closer to 10% and grow earnings at a faster clip, the market has shown a willingness to value a slow growing software company at higher valuations. One prime example is Intuit (NASDAQ:INTU) that trades at over 24x forward EPS estimates.
For Symantec to thrive it has to figure out how to turn the 80% legacy business that is in decline into a growth business. If the Blue Coast division grows revenues by a similar 17% in the current FY to revenues of $883 million, the combined business will grow in the range of 2%. The market isn't likely to reward the stock with a much higher P/E multiple with that growth rate.
The key investor takeaway is that Symantec probably only has upside to the low $20s unless the company can convince the market that revenue growth opportunities exist. Even this target assumes the company can increase EPS numbers by reducing debt and the interest expense levels over the next couple of years.
Opportunity exists for significant upside, but no signs exist that Blue Coat will actually transform the company into a new growth phase.
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