On Apple Bonds

by JT McGee

Everyone else is writing about it, so why not me?

Apple just raised $17 billion in what was the largest debt offering in history, beating a $16.5 billion offering by Rosche. No doubt, Apple, Goldman Sachs and Deutsche Bank just wanted to claim that number one spot.

Why Apple is borrowing heavily

Apple has a tremendous amount of cash on its balance sheet. The company has $145 billion in cash, much of which is overseas, currently untouchable by Uncle Sam. When a company brings foreign profits back to the United States, it has to pay the corporate tax rate (roughly 35%) minus taxes paid abroad. Thus, if Apple pays 5% in income taxes on foreign profits, it would have to pay another 30% should it bring that cash stateside.

By borrowing in the United States, Apple can borrow cash to pay dividends and make repurchases in the United States without paying taxes to bring its foreign money home.

In effect, Apple is engaging in some kind of tax rate-risk arbitrage. Apple is choosing to borrow funds inexpensively on the hopes that:

  • Corporate taxes in the United States are lower in the future.
  • The United States offers some kind of repatriation holiday, in which US-based corporations get a one-time chance to bring cash back home at a lower rate. The last repatriation holiday was in 2005, when companies brought money home at a low 5.25% tax rate.

Issuing debt to avoid current taxes is more affordable than at any time in recent memory. From the Wall Street Journal:

It borrowed $5.5 billion for 10 years at an annual yield of 2.415%. It also issued three-year debt at 0.511%, five-year debt at 1.076% and 30-year debt at 3.883%.

In 2005, for example, this maneuver wouldn’t be so economical as it is today. The 10-year US Treasury had a yield between 4 and 5 percent in 2005. In short, Apple is borrowing more cheaply today than the US government borrowed in 2005. That’s pretty insane to think about.

Odds-on for a repatriation holiday

Will the United States offer another repatriation holiday? There’s nothing that says it is certain. For one, the current political climate does not favor proper tax strategy, which can be easily labeled as use of a “tax loophole” or “tax evasion” and plastered all over TVs in American living rooms.

On the flipside, though, betting on a tax holiday looks like a fantastic option for AA-rated credits like Apple. Supposing that in 10 years, the US government offers a one-time repatriation holiday at a tax rate of 5.25%, companies like Apple would knock off 30% from their tax bills due. In the meantime, Apple would have paid only 24.15% in pre-tax interest costs. Net of the corporate tax rate, that’s about 18%.

So, total savings? 35 – 5.25 – 18% paid on debt, for a ~12% reduction in taxes by delaying payments to Uncle Sam. Not too shabby – and I didn’t include Apple’s current earnings power on its cash balances. Apple’s current dividend yield of 2.9% is heavier than the cost of servicing its newly-issued debt. Thus, for each share repurchased with borrowed money, Apple will actually conserve cash.

On Apple as an investment

I’ve written about Apple in the past, criticizing the company’s terrible capital allocation. A combination of David Einhorn’s off-the-wall preferred stock proposal and shareholder annoyance with a falling stock price finally got through to Apple executives that the company needed to do something with its bloating cash balances.

As for the debt or equity, neither strike my fancy. Even though Apple is valued at about 8 times free cash flow with more than a third of its balance sheet in cash, it’s not as cheap or as predictable as many of the small and microcap stocks I find in the fiery hell of the Pink Sheets. However, it is much more compelling given that Apple finally recognized that capital allocation is key to the new investors it must appease.

I just don’t do the whole technology stock thing. I could have never predicted the iPhone, the iPad, the failure of the GPS, the rise of Facebook, or the death of Kodak to happen when they did. Besides, it’s free to be a spectator.

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