Because I don’t know approximately what the future of phones will hold, I cannot comment intelligently on the long-term future of Apple into 2024 and beyond. However, I can comment on what the U.S. tax system and Apple’s new commitment to financial engineering (through stock buybacks) have done to the company’s balance sheet.
One of the very many peculiarities of our tax system is that companies domiciled in the United States have to pay a repatriation tax to bring money generated outside the U.S. back to American coffers. If a corporation files a form indicating that the money will be kept permanently overseas, then there is no tax. If the money is bought back home, there is a 35% tax applied to the income. If you’re ExxonMobil, this is what the incentive picture looks like to you: You generate $100 million in profits in Brazil. You can (1) bring that money back to the United States to pay dividends, repurchase stock, or drill new oil fields, but you will only have $65 million to deploy after paying the U.S. federal government for the right to transfer that money from Brazilian banks to American banks. OR (2) you can permanently reinvest that $100 million into new Brazilian growth prospects, and Uncle Sam will get 0%.
Because of these distorted incentives, Apple finds itself keeping the large bulk of its cash hoard overseas. You’ll often see headlines touting the fact that Apple has $156 billion in cash sitting on its balance sheet. You would be correct to note that it is a substantial amount. Considering that Apple is a $600 billion company, the cash hoard amounts to 25% of its market valuation. You might look at it and think, “Wow, Apple is trading at $100 per share, and could pay out a one-time dividend of $25 to shareholders, just from the cash on its balance sheet.”
That is absolutely correct at a theoretical level, but the reality is somewhat different. Sure, Apple may be sitting on $156 billion in cash profits, but only $18 billion of that is here in the United States. The other $138 billion is abroad, and would instantly become $90 billion if it was all instantaneously brought back to the United States in one fell swoop. That is why it would be borderline idiotic for Apple to repatriate its cash—it would have to pay the equivalent of FORTY St. Louis Cardinals’ franchises in tax to the U.S. government just for the act of gathering the profits in British, Irish, Korean, French, and Chinese banks and putting them inside U.S. banks instead.
You may have noticed the recent headline claiming that Apple is adding $30 billion to its buyback program. You may also notice that the company pays out a $0.47 quarterly dividend on its 6 billion shares, so that the company is currently on the hook for $11.2 billion in annual payments to shareholders. So the nuts-and-bolts analysis of the company becomes this: All those $11.2 billion dividend payments, all those $30 billion buybacks, and all of Apple’s continued investment inside the United States would have to come from that $18 billion in American cash.
The only alternatives would be to (1) repatriate cash and pay that 35% tax, or (2) take on debt. As you can guess, Apple has chosen door #2. As of this past July, Apple has taken out $31 billion in debt (and makes payments that amount to $2 billion annually on it) to meet its liquidity needs inside the United States. It’s crazy—because of the disincentives created by the tax code, a company with over $150 billion in cash has to take on $30 billion in debt to meet its operational requirements and promises of buybacks, dividends, and American investment.
On the buyback front, Apple has reduced its share count from 6.57 billion to 5.98 billion over the past twenty-four months. Put simply, Apple is retiring around 4.60% of its stock per year. In other words, even if the company’s annual profits remained steady at $37 billion per year, you would still experience 4.60% annual returns if the company remained valued at 16.3x profits as your share of corporate profits increased at a rate of 4.60%. If the company grows profits at 5.40% annually over the next ten years, and maintains buybacks at the same pace, then you will achieve 10% annual returns from price advances in the stock plus you’ll get a dividend to boot.
If you’re a student of these things, you got to love kicking back with the popcorn and watching this sucker play out. On one hand, the phone market is notoriously fickle. Twenty years from now, you know you’ll see people eating a Hershey’s candy bar. But twenty years from now, will people be walking around glued to an Apple phone? It was just seven years ago that Research In Motion’s Blackberry was a thing. On the other hand, $37 billion in annual profits gives you a lot to play with. Retiring 4-5% of the stock each year has been great for long-term shareholders of ExxonMobil, and it’s fair to see traces of that path based on what Apple is doing right now. Long-story short: Apple has $150+ billion in cash, but only $18 billion in America due to tax considerations, and this has forced Apple to borrow $30 billion in debt. The company is retiring around 4-5% of its stock each year, and I’m curious to see how this interacts with the core business performance in the years ahead. Your guess is as good as mine.
Originally posted 2014-10-14 04:15:57.
Hey Tim, At first I thought the repatriation tax was the worst idea in the world but the more I thought about it I am not so sure. I am now thinking the repatriation taxes could ironically be making US companies more globally competitive. It forces US companies to make foreign investments or pay huge taxes. This in turn causes US companies to invest a lot of capital into foreign markets and in turn dominate on a global scale. Could the repatriation tax be part of the reason that US companies are so successful on the global stage?
frfrizzo381 Good question! The dilemma is this: What if a company generates significant cash flow, in say Ireland, but identifies a $5 billion project in California that might grow at 13%, but can reinvest into Ireland at 12%? You’re going to reinvest into Ireland.
It’s not the end of the world–a company can take on debt, projects perform differently than initial expectations, and so on–but we have a systemic disincentive against U.S. growth. Without this hurdle, you’d still be drinking Coke in Mexico, Ireland, France, South Africa, Australia, and on and on—but what happens when Japanese profits could more effectively go towards a Texas project?
You’re right to note that the convoluted tax structure can be overcome by savvy individuals, and it does come with some side benefits (though, wouldn’t Coca-Cola invest more in Ireland anyway if they identified a 13% annual returning project compared to a 12% returning one in the U.S.?).
I too agree the US tax system is creating distortions to the global economy in which it is harming Americans themselves. Not just foreign cash horde, all this tax inversion debate is silly as well, and can easily be avoided if anyone willing to reform the tax code. Sadly US politics is so grid locked that I do not see hope for any sensible tax reform soon especially with Democrats are current favourites to win the next presidency despite a GOP-dominated House and GOP is favoured to dominate the Senate to take control in a few months.
A really bad thing about cash hoards is that cash is guaranteed to reduce in value with time. Holding cash is the worse ever investment, and it is unproductive to the economy. In the long run, value can be only gained by spending cash on items with utility.
Borrowing money for buybacks and dividend is not generally healthy in the medium and long run. That said, if Apple (and IBM) can borrow are very low rates for now, it does kind of make sense.