U.S. Markets closed

Understanding Apple's New "Net Cash Neutral" Goal

Apple (NASDAQ: AAPL) has long had more cash than the company knows what to do with, far more than needs to operate. Historically, the challenge has always been that most of this cash is held by foreign subsidiaries, in order to avoid repatriation taxes under the previous tax code. With tax reform just recently passed, the iPhone maker now has much greater access to those foreign reserves, giving it many more options in terms of capital structure.

But having that flexibility still doesn't address the simple fact that Apple has and generates too much cash.

Apple Store in Chicago on Michigan Avenue
Apple Store in Chicago on Michigan Avenue

Image source: Apple.

Going for "net cash neutral"

On the earnings call last night, CFO Luca Maestri set a bold goal: Apple plans on bringing its net cash position to zero in the years ahead. Here's Maestri (emphasis added):

Tax reform will allow us to pursue a more optimal capital structure for our company. Our current net cash position is $163 billion, and given the increased financial and operational flexibility from the access to our foreign cash, we are targeting to become approximately net cash neutral over time. We will provide an update to our specific capital allocation plans when we report results for our second fiscal quarter, consistent with the timing of updates that we had provided in the past.

In case it wasn't clear, CEO Tim Cook clarified later on the call that this means that Apple will have an "an equal amount of cash and debt, and that they balance to zero." It goes without saying that Apple needs billions of dollars in working capital just to operate. For historical context, here's how Apple's cash and debt positions have grown over the past seven years.

Chart comparing cash and debt over the past 7 years
Chart comparing cash and debt over the past 7 years

Data source: SEC filings. Chart by author. Calendar quarters shown.

While investors will have to wait until next quarter's release for more granular detail, it's worth considering the implications of this strategy now.

Is a massive boost to capital returns coming?

If Apple's goal is to bring net cash to zero, it will have to either reduce gross cash, increase debt, or some combination of the two. Debt was always a temporary solution to avoid repatriation taxes, and the company doesn't need to continue issuing paper now that tax reform has passed. The resulting implication is that Apple may be considering a massive increase in its capital return program to reduce its gross cash position.

Theoretically, that could take the form of a special one-time cash dividend, or a significant boost in share repurchase authorization. Or Apple could start pushing more aggressive annual dividend increases, although that would take quite a while to deplete $163 billion. Income investors like consistent and reliable annual increases, so taking a long time isn't necessarily a bad thing if Apple goes this route.

There's no rush, and investors still don't know what time frame we're talking about here, but these are the basic options that Apple is probably considering.

What happens next?

What's less clear is what happens with existing debt. Apple bonds are callable so the company could potentially choose to extinguish debt and the related interest expense. Alternatively, it could continuously roll over the current debt load with new issuances as tranches mature. Or it could plan on having sufficient cash on hand when those bonds mature to pay them off naturally over time on schedule.

As with capital returns, there's also no time pressure here. Remember that Apple's debt structure includes bonds that extend well into the 2040s -- the longest maturity currently is 2047 -- so the Mac maker has decades of visibility, and interest expense is negligible since dividend and interest income covers those costs.

This new "net cash neutral" target will have a lot of moving parts with complex considerations. We'll find out more in about three months.

More From The Motley Fool

Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.