Why Is Apple Raising Debt In Spite Of A $178 Billion Cash Pile?

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Why Is Apple Raising Debt In Spite Of A $178 Billion Cash Pile?

Apple cash on hand has been a topic of debate among investors. Apple’s treasure chest swelled to $178 billion at the end of December 2014. With a net Cash (adjusted for debt) position of $145 billion at the end of December 2014, Apple added to its debt with a recent $6.5 billion bond issuance, per a Bloomberg report. Moreover, Apple cash balance will continue to rise, if the increasing revenue from its iPhones and growing popularity of the Mac is any indication. Why would you borrow money when you have a hoard like Apple’s? Surprising, isn’t it?

Much of Apple’s  cash is stashed overseas

The geographical spread of Apple cash is the key to understand these seemingly unusual developments at the Cupertino based technology innovator. Ninety percent of Apple’s reported cash is stashed in international subsidiaries, leaving a mere $20 billion of it within the United States. Using the “Double Irish taxation” structure, Apple has been able to avoid the hands of the US taxman, keeping its international cash outside the reach of Uncle Sam.

Apple executing a massive capital return program

Apple is executing a capital return program of over $130B, which requires it to spend billions of dollars every quarter. The capital return program consists of a share repurchase plan and dividend payouts to investors.

Quoting from Apple’s latest 10-Q filing,

“In April 2014, the Company’s Board of Directors increased the share repurchase program authorization from $60 billion to $90 billion of the Company’s common stock, of which $72.9 billion had been utilized as of December 27, 2014. The share repurchase program is expected to be completed by the end of December 2015.”

“The increase to the Company’s share repurchase program authorization resulted in a total capital return program of over $130 billion. The Company expects to complete the capital return program by the end of December 2015 by paying dividends and dividend equivalents, repurchasing shares and remitting withheld taxes related to net share settlement of restricted stock units. To assist in funding its capital return program, the Company expects to access the debt markets, both domestically and internationally.”

Apple’s capital return program, which was started in August 2012, has a target of returning $130 billion to shareholders by the end of December 2015. The capital returned to shareholders since the inception of this program is over $102 billion.

Source: Apple 10-Q

Apple also states that the capital return program will be financed by debt issues.

An obvious question to ask is why Apple can’t use its overseas cash to fund its requirements instead of repeatedly dipping into the bond markets. Repatriation of cash is subject to a 35% federal tax rate, which would mean an enormous tax bill for Apple, should it choose to repatriate its overseas cash. Based on the overseas cash at the end of December 2014, repatriation would lead to a tax bill of $55.2 billion for Apple, which would be a significant loss for shareholders. Hence, Apple has chosen to access debt markets in order to fund its capital return program as well as operating expenses of the United States based parent company.

Debt issues cost Apple lesser than cost of cash repatriation

Another major reason for raising debt lies in the cost of debt versus cost of repatriation. Apple has raised debt of varying maturities at costs (interest rates) ranging from 0.45% to 4.45%, as per its 10-Q filing. On the other hand, the 35% tax on repatriated funds can be viewed as the cost of repatriating overseas cash. Simple math tells us that Apple is better of raising debt than repatriating its cash.

Will Apple repatriate its cash ever?

Apple could indefinitely hold its overseas cash in foreign dollar denominated holding. However, a couple of tax reforms are being discussed, which will encourage US multinationals to repatriate cash by providing a tax break.

Option 1: President Obama’s proposal

President Barack Obama has suggested a one-time tax break to facilitate tax collection on $2.1 trillion cash stashed away by US multinationals in foreign countries. According to a post on theguardian.com, the US president’s plan could boost US GDP by 1.5%, raising at least $238 billion in taxes. The president’s proposal plans to levy a onetime 14% charge on cash held offshore followed by a 19% tax on future profits earnings.

Offshore cash reserves (Q1 2015):      $157.8b
Repatriation charge under current law:     $55.2B
Repatriation charge under President’s proposal: $22.01b
Savings for Apple: $33.1B

The president’s proposal could help Apple save $33 billion in repatriation charges. However, in reality, the tax bill would have a much lower impact on company’s financials as Apple has pro-actively made income tax provisions for part of its foreign cash holdings. Additionally the 19% tax on future tax repatriations could reduce Apple’s tax rate in future periods.

Option 2: Invest in transportation act of 2015

Senator Barbara Boxer (D-CA) and Senator Rand Paul (R-KY) have proposed to introduce the “Invest in transportation Act” which will encourage the MNC’s to repatriate foreign cash holdings at a 6.5% repatriation tax rate. However, the proposal comes with restrictions on the usage of the repatriated cash. Quoting from boxer.senate.gov website:

“The legislation would strengthen the U.S. economy and create jobs by allowing companies to voluntarily return their foreign earnings to the United States at a tax rate of 6.5 percent. The rate is only for repatriations that exceed each company’s average repatriations in recent years, and funds must have been earned in 2015 or earlier. Companies would have up to five years to complete the transfer.”

A pdf copy of the senators proposal is also available for viewing. However, the repatriated funds can only be used for increased hiring, wages and pensions, R&D, environmental improvements, public-private partnerships, capital improvements, and acquisitions. The funds cannot be spent on increases in executive compensation or on increases in shareholder dividends or stock buybacks for three years after the program ends. The restriction on use of repatriated cash for capital return program will hinder Apple’s ability to use the cash as it pleases. For example, Apple cannot plough in this $150 billion repatriated cash to R&D, Capex or acquisitions, limiting the benefits of the proposal for Cupertino.

Conclusion

Apple has consistently raised debt over the last couple of years to finance its capital return program. It is counter intuitive that a firm with the highest corporate cash hoarding would resort to debt. However, a deeper look into the geographical spread of this cash pile answers the question as to why Apple is raising debt. The bulk of Apple’s cash on hand is located in international subsidiaries, repatriation of which would cost Apple a huge 35% in taxes. On a comparative note, Apple is able to access the debt markets at a rate of less than 5%. Therein lies the answer as to Why Apple is raising debt to finance its capital return program.

The growing popularity of its iPhones and revival of growth in MAC shipments, upcoming launch of Apple watch and the successful launch of Apple Pay make Apple a highly valuable stock. Amigobulls holds a positive long term outlook on Apple stock, as reflected in the Apple stock analysis video.