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Apple's buyback and bond issue

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May 01, 2013 – Comments (15) | RELATED TICKERS: AAPL

 

This is all about taxes, so bear with me.

 

Let's, for the sake of argument, say that AAPL has $50 billion overseas - out of the USA, where they are based - and that they desire to return this money to shareholders for shareholder benefit.  This is, by the way, true as far as I can determine in terms of what was said by Tim Cook, CEO, on the last earnings conference call.

 

They could do it this way:

 

1)  Repatriate $50b of cash.  Incur an immediate 35% tax on that money, so that they really only have $32.5 billion to use.

 

2)  Pay 32.5 billion to shareholders in the form of a $36/share special dividend.  Most dividend holders immediately incur a 20% tax on that.  Total cash returned to shareholders net of taxes is $26 billion.  Not very good for a $50 billion expenditure.

 

3)  Results:  nearly 50% of the money lost to taxes.  No tax benefit accrues to AAPL or anyone else.  Going forward, AAPL's share count remains unchanged and their future dividend payouts and P/E are

unaffected by the transaction.

 

Or they could do it this way:

 

1)  Repatriate NO cash.

 

2)  Borrow $50 billion in the bond markets in the US between now and 1Q16.  Let's say that today's rate, 2.415%, is approximately what they have to pay on this.

 

3)  Use the money to buy back shares.  AAPL's trading around 438 right now; let's say they can get the shares they want at $450.  (At $450, AAPL's annual dividend yield is about 2.5%).  

 

4)  Results:  No repatriation tax hit to AAPL.  No dividend tax hit to AAPL shareholders.  Shareholders who choose to sell get the price they wanted for their shares.

 

5)  Approximately 12% of shares out are retired by this maneuver.  This immediately boosts future P/E figures by 12%.

 

6)  The retired shares no longer incur a dividend expense.  Annual yield was 2.5%, and AAPL is paying 2.4% for the privilege of having the money they are using to buy back shares, so AAPL immediately benefits cash-flow-wise because their cost of new capital to retire shares is less than they would have paid in dividends.

 

7)  Unlike dividend expense, interest expense is tax-deductible.  On $50 billion at 2.4%, the interest is $1.2 billion annually.  Assuming a 33% marginal income tax rate, Apple suddenly profits by lessened tax expense of $400 million a year on this transaction - sure, not much compared to gross revenue, but heck, any time a company I own has a chance to get $400 million free, I would advise them to take it.

 

One of the strongest bear cases for AAPL was this:  who commands enough capital to 'move the needle' on AAPL's market cap and share price?  Well, AAPL themselves do.  Warren Buffett knew this and publically advised Tim Cook to undertake this maneuver a few months ago.  It is a no-brainer; it is a win for everyone except the U.S. Treasury.

 

Even L0RDZ has to admit that.  :)

 

15 Comments – Post Your Own

#1) On May 01, 2013 at 8:13 PM, ikkyu2 (99.15) wrote:

  This immediately boosts future P/E figures by 12%.

I probably could have expressed this better.  It'd be more accurate to say that, all else being equal, the move immediately boosts future earnings per share by 12% because earnings are unchanged by the maneuver and number of shares has decreased.

Earnings per share is the denominator of P/E, of course; the numerator of P/E is share price per share.  (This is a little weird, but I assure you it is the best way of thinking about it for the purpose of this calculation!) 

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#2) On May 01, 2013 at 8:30 PM, ikkyu2 (99.15) wrote:

Also, on the issue of retiring dividends with borrowed money:

1)  In general, and certainly in this case, bonds are eventually repaid - the obligation to repay principal and interest is not expected to continue forever.  When it is over, that is viewed as a positive for the borrowing company, not a negative, as it strengthens the balance sheet.

2)  In general, dividends are expected to be an obligation that is ongoing, financed by growing earnings.  When a company ends or reduces its dividend payouts, it is generally perceived to be a negative for that company, as it is taken as an indicator that earnings will decrease.

So in this scenario, AAPL is doing away with an ongoing obligation that never ends, in favor of a ten-year obligation that ends; the ten year obligation is cheaper on the face of it, and in addition they are receiving a hefty tax bonus for doing so.

There are all kinds of ways to discount the present value of future obligations, which I will not attempt here, but clearly AAPL comes out the big winner here no matter what method you choose. 

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#3) On May 01, 2013 at 8:33 PM, ikkyu2 (99.15) wrote:

OK, since I'm having fun here, I am going to throw this one out:

There is a major risk to Tim Cook's plan; however, if it comes to pass, it will actually be *good* for current AAPL shareholders.  Can  anyone see it?

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#4) On May 01, 2013 at 11:08 PM, rd80 (98.29) wrote:

A big risk to borrowing at today's low rates for a share buyback is that the principal needs to be repaid in the future and there's no way to predict what rates will be when the debt matures.

Basically the maturing debt will need to be paid with:
 - Cash on hand; Apple will have this option if they don't blow the cash hoard, but it comes with the repatriation tax issues
- Sell shares; undoes the buyback and could be ugly if the share price is in a slump.
 - Refinance with new borrowing; the most likely scenario, but if rates are up or markets are tight, it could be tough.

Any company employing the borrow-to-buyback strategy also risks getting its credit rating dropped, which raises borrowing costs, if they push the strategy too far.  I don't see this as an issue for Apple unless it greatly expands its borrowing plans.

Many companies have played the borrow-to-buyback game over the past few years and they've often been able to improve cash flow by paying less after taxes for the debt service than the dividends on the purchashed shares - exactly as you describe.  With rates where they are, I sometimes wonder why more companies don't do it.

I'm not surprised Apple's borrowing for its capital return plan.  I do wonder what the buyers of those bonds are thinking.  After all, AAPL is essentially going short debt/long the stock.  Why take the other side of that trade when it virtually guarantees a loss of purchasing power?

 

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#5) On May 01, 2013 at 11:17 PM, rd80 (98.29) wrote:

Since we're rolling, I'll add a little shameless self promotion.  I touched on Apple's bond issue in my latest bond market summary.

Also should have added, I like your rundown.  This is a great example of why stock investors should pay attention to credit markets as part of stock research.

Oh, one more risk to the buyback plan.  The stock price could take off and the company wouldn't be able to retire as many shares.

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#6) On May 02, 2013 at 2:37 AM, Valyooo (99.41) wrote:

Oh, one more risk to the buyback plan.  The stock price could take off and the company wouldn't be able to retire as many shares.

 

High-quality problem ;) 

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#7) On May 02, 2013 at 8:49 AM, Option1307 (29.75) wrote:

Agreed!

 

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#8) On May 02, 2013 at 9:51 AM, rd80 (98.29) wrote:

Would you mind if I include a link to this blog in my next bond review article?

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#9) On May 02, 2013 at 10:21 AM, rofgile (99.32) wrote:

Great thread ikkyu2!  I became an Apple shareholder again at $408 a share, and think this will be an interesting year.

-Rof 

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#10) On May 02, 2013 at 12:25 PM, ikkyu2 (99.15) wrote:

You nailed the risks, rd80 - the main one I'd had in mind was simply that the stock price would take off and AAPL wouldn't get to do its buyback at a favorable share price.  Like Valyoo says it's a high quality problem :)

You are welcome to link this or whatever you like - I'm flattered.

Basically the maturing debt will need to be paid with: - Cash on hand; Apple will have this option if they don't blow the cash hoard, but it comes with the repatriation tax issues 

Are we sure about that?  Are we sure, for instance, that AAPL couldn't pay these bonds back overseas?  I mean, there must be a reason they involved Deutsche Bank.  If DB is named as the agent for acceptance of repayments, the money never has to enter the US at all? 

 

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#11) On May 02, 2013 at 12:47 PM, L0RDZ (82.15) wrote:

This  will  all end   like it  ended  on   "No country  for  old men"

Badly...

http://www.youtube.com/watch?v=oEaa0RYYTw8

You'll see...  lol.

 

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#12) On May 02, 2013 at 2:36 PM, awallejr (81.55) wrote:

Whenever you are dealing with a 30 year prediction which is what its 30 year bond is basically doing, you always run risks.  But at these low rates and tax incentives it makes sense in what they are doing.

Congress really does need to take a look at "profit repatriation" since bringing all that cash held by the multi-nationals over seas could be a big boon to the economy here.  Of course the downside is that you would encourage overseas operations if they get better tax treatment than in the US.

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#13) On May 03, 2013 at 5:40 PM, rd80 (98.29) wrote:

Are we sure about that?  Are we sure, for instance, that AAPL couldn't pay these bonds back overseas?

I hadn't ever thought of this and am not sure.  I suspect the IRS would see it a repartriation of the money unless maybe the bond holder took payment overseas and kept the money there.

I did see a recent example of a company - Diageo - borrowing US$ to repay euro denominated debt. 

If companies could pay back bonds overseas and not get hit with taxes, it would be an easy back door way to bring money back.  Borrow short term here, then make a tender offer to buy the paper back through an overseas subsidiary.  There would be filing fees and other costs, but probably much less than the tax bill.  I'm not even sure where to dig to find the answer.

Guess I need to take a course in international finance if I really want to understand this stuff.

As for DB's involvement, it's not uncommon for international banks to be underwriters on bond deals.  If the reason was to allow overseas repayment, seems like that could be done through any multinational finance company.

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#14) On May 04, 2013 at 2:17 PM, ikkyu2 (99.15) wrote:

Well, if you find out anything more definitive, Russ, let me know - I'm curious.

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#15) On May 04, 2013 at 10:43 PM, tomlongrpv (76.63) wrote:

I still wish I had bought more than just 200 shares back when AAPL was $86.  And maybe I should have dumped some or all when it was $700.  But I still think it is a good long term investment and this thread helps me better understand why that is likely the case.

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