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Orlando's Outlook: Apple bond deal indicative of corporate tax-policy madness

As of 05-10-2013

Bottom line Last week, Apple Inc. came to market with a $17-billion corporate debt offering, the largest such bond deal in history. But its successful underwriting begs an obvious question. Why would a company with $145 billion of cash already on its balance sheet—and which is generating an incremental $150 million in new cash every day from operations—need to borrow any money at all? The answer, in our view, points to the dysfunction of corporate tax policy here in the U.S., and the desperate need for our elected officials in Washington to undergo comprehensive fiscal-policy reform.

Why does Apple need the money? After Steve Jobs’ death in October 2011, investors began to raise legitimate questions about the future of the company without its CEO, co-founder and visionary. Still, the stock continued to rise from about $400 to $705 in September 2012. At that point, however, the market began to perceive that Jobs’ once-full cupboard of great new ideas was bare, and that the company’s existing product line of extraordinarily popular mobile communication devices was rapidly becoming mature. Over the subsequent seven months, Apple’s stock price plunged 45%, reaching $385 on April 19, on rampant fears it had gone “post-growth.”

So if Apple was no longer a pure “growth” company, then management needed to quickly redefine itself and appeal to a new class of “value” investors, which dictated that they begin to return some of their cash hoard to investors. Toward that end, new CEO Tim Cook announced on April 23 that Apple would return $100 billion to investors through the end of 2015 in a combination of dividend increases and share repurchases: 

  • Dividend hike Apple increased its quarterly cash dividend 15% from $2.65 per share to $3.05, payable May 16 to holders of record May 9, putting the new annual dividend at $12.20 per share and the yield at a respectable 2.7% compared with a 2.1% yield for the S&P 500. With 938.6 million shares outstanding, that translates into total dividend payments of about $35 billion over the next three years. 
  • Share buyback Management also increased its current share-repurchase authorization from $10 billion to $60 billion over the next three years, its largest such plan in history. A stock buyback reduces the number of shares outstanding, which can increase earnings per share and boost the value of the company. At a current market capitalization of about $423 billion, Apple’s planned $60-billion repurchase could boost the value of the shares by about 14%.  

So what’s the problem? The issue is that even though Apple has $145 billion of cash on its balance sheet, $102 billion of it is sitting overseas. The only way for Apple to use those proceeds is to first pay a repatriation tax. At present, the U.S. has the highest repatriation tax in the world at a statutory 39% rate (35% of which is federal), and we’re quite sure that Apple has no interest in paying a $40 billion tax to gain access to its remaining $62 billion—particularly when it can borrow money from yield-starved investors here in the U.S. for next to nothing, courtesy of the Federal Reserve’s extraordinarily accommodative monetary policy. This situation puts U.S.-based multinational companies (like Apple) at a competitive disadvantage globally, and it creates the sort of market distortions and imbalances that we’re discussing here. 

Terms of the deal Underwritten by Goldman Sachs and Deutsche Bank, the bond offering was hugely oversubscribed by a 3-to-1 ratio, and Apple was able to borrow a record $17 billion in six tranches with different maturities at very attractive interest rates.  The biggest block was $5.5 billion in 10-year paper issued at about 2.4%, compared with a benchmark 10-year Treasury yield of about 1.65% at the time of the deal 10 days ago and 1.90% currently. Moody’s and Standard & Poor’s gave the new Apple paper their second-highest credit ratings, and Apple’s interest payments on the bond offering will be tax deductible. 

What might corporate tax reform look like? Most of Washington fully recognizes that the corporate tax system is broken, but few can agree on how to fix it. Generally speaking, Republicans want lower tax rates, a cleaner code with fewer loopholes and deductions, a broader base of companies paying taxes, and stronger economic growth to generate more revenues. Democrats, on the other hand, simply seem to want to raise more corporate tax revenue for the federal government. 

Here are four key issues:

  • Lower the rate President Obama proposes cutting the current 39% statutory rate, the highest in the world among developed economies, to 28%. While this is a good starting point, the global corporate average is 25%.
  • Repatriation issue U.S.-based multinational companies collectively have more than $1 trillion in cash sitting on their overseas balance sheets. Most, like Apple, would like to bring that cash home at a less punitive repatriation tax rate (say 5-10%, for example), which might result in a hypothetical split of $50-100 billion for the federal government and $900-950 billion for the companies. What might the companies do with their money? Like Apple, many would opt for share repurchases and dividend increases, while others would fund mergers & acquisitions, corporate capital expenditures, and increased hiring. This is a win-win for everyone, as the federal government could use the revenue windfall to help repay $16.7 trillion of debt, while the corporate use of the cash would boost both the economy and the financial markets.
  • Territorial tax issue Most countries require their multinational companies to pay taxes in the host countries in which they are doing business, and bring the remaining profits home tax free. 
  • Clean up the U.S. corporate tax code The code is littered with unproductive loopholes and deductions, which need to be eliminated to broaden the base, level the playing field, and generate more revenue. 

‘Abenomics’ a touchstone for U.S. Japan’s new prime minister, Shinzo Abe, and the new chairman of the Bank of Japan (BOJ), Haruhiko Kuroda, have collaborated on an aggressive new fiscal and monetary policy initiative to reinvigorate a Japanese economy that had previously been moribund for the past two decades. 

There are three key elements to their policy: 

  • Cut corporate tax rates Through 2011, Japan had the highest corporate tax rate in the world among developed economies at 40%, but they are in the process of reducing that rate to the global corporate average of 25%.
  • Monetary policy stimulus The BOJ is aggressively injecting liquidity into the Japanese economy through asset purchases, at a pace 2½ times as aggressive as Ben Bernanke and the Federal Reserve have done here at home.
  • Devalue the yen As a result of flooding the Japanese banking system with liquidity, the central bank is also tacitly encouraging a devaluation of the yen, which boosts export volumes and profits for Japan-based multinational companies, because it makes their products or services relatively cheaper.  Since last November, the yen’s value has fallen by 25%, from 80 for each U.S. dollar to 100 currently, for the first time in four years. 

As a collective result of lower corporate tax rates, aggressive central-bank easing and a cheaper currency, Japan’s Nikkei stock index has soared by 68% over the past six months. This, in turn, has generated a stronger wealth effect, which will boost economic growth, hiring, wages and government revenue generation in Japan.


 
 
 
 
 
 
 
 
 
 
 
Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.
Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.
Credit ratings do not provide assurance against default or other loss of money and can change.
The dividend yield represents the average yield of the underlying securities within the portfolio.
Japan's Nikkei 225 Stock Average is a price-weighted index comprised of Japan's top 225 blue-chip companies on the Tokyo Stock Exchange.
S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.
Federated Global Investment Management Corp.
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