Was Gilead Sciences Inc.'s Dividend a Good Idea?

By Markets Fool.com

Source: Gilead Sciences.

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Gilead Sciences surprised investors when it recently announced that it will begin returning some of its cash stockpile to investors in the form of a dividend. Since dividend-paying biotech stocks are a bit of a rarity, we asked two Motley Fool healthcare experts for their opinion on whether Gilead Sciences' dividend plan makes sense. Read on to learn what they think.

Brian Orelli: There's nothing inherently wrong offering dividends. If management can't find anything better to do with the cash the company is generating, returning it to shareholders is the right move.

It's the "can't find anything better" part that I don't get about Gilead's decision to start a dividend. The company has been pretty good at creating value, both with internally developed drugs and with smart acquisitions such as Pharmasset, which propelled Gilead to the front of the hepatitis C market.

You could argue that the biotech sector, in general, is a little overheated, and it might be hard to find deals that make financial sense. But that's a temporary situation. Holding the cash until the sector swings back in the other direction might still result in a better long-term return for investors.

Of course, the dividend is relatively small right now, so at this point it won't have a major effect on Gilead's ability to acquire companies or license drugs. But the thing about dividends is that investors expect them to grow. It doesn't take too many years of dividend raises for a small dividend to become a big chunk of the company's cash flow.

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At that point, if there's a major acquisition opportunity, Gilead's management will be stuck with the untenable situation of either cutting the dividend -- as Pfizerdid after its acquisition of Wyeth -- or pass up on the opportunity.

I'm not saying Gilead should never offer a dividend, but I think the decision was a little premature.

: In my opinion, Gilead's investors deserve a dividend after riding out the stock's news-driven volatility over the past few years.

Before blockbuster HCV drug Sovaldi was approved, investors were worried about the 2017 patent expiration of Viread, the heart of Gilead's HIV franchise. After Sovaldi and its next-generation HCV drug Harvoni were approved, Gilead was weighed down by pricing concerns over the new drugs, which resulted in lawsuits and Express Scripts'decision to completely drop the company's HCV drugs. As a result, Gilead gained only 24% over the past 12 months, underperforming the Nasdaq Biotechnology Index's 28% gain. Introducing a dividend might attract new investors and persuade them to hold Gilead stock longer.

One might argue that Gilead needs more cash to spend on R&D and inorganic growth instead of buybacks and dividends, but it has more than enough free cash flow to do both. Gilead generated FCF of $10.1 billion over the past 12 months and spent $3.4 billion on buybacks. Paying a quarterly dividend of $0.43 per share, a yield of around 1.75%, would cost it $2.6 billion per year.

If Gilead maintains its current FCF levels, it will still have billions left over, along with $11.7 billion in cash and equivalents, to spend every year on R&D and acquisitions. If FCF starts falling, it could simply reduce its big buybacks to maintain dividend growth.

The article Was Gilead Sciences Inc.'s Dividend a Good Idea? originally appeared on Fool.com.

Brian Orelli has no position in any stocks mentioned. Leo Sun owns shares of Pfizer. The Motley Fool recommends Express Scripts and Gilead Sciences. The Motley Fool owns shares of Express Scripts and Gilead Sciences. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.