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Why Companies Like Apple Took On Debt Ahead Of Tax Cut On Overseas Profits

Shanthi Rexaline

The Trump administration's tax reform law has proved a windfall for companies, as it reduced the corporate tax rate and provided incentive for repatriating cash held overseas.

The corporate tax rate is now lowered from 35 percent to 21 percent, and bigger companies can now repatriate overseas profits held as cash at a reduced rate of 15.5 percent. For repatriating illiquid assets, the relevant tax rate is now a more modest 8 percent.

Apple Inc. (NASDAQ: AAPL) said on its earnings call that it plans to spend the repatriated profits, aligning its cash with the debt.

In a December note, KeyBanc Capital Markets analyst Andy Hargreaves said he expects Apple's potential tax rate to change from the current 25.5 percent to 12.3 percent in 2018.

The Cash-Debt Balance

Apple ended the fiscal first quarter 2018 with cash, plus marketable securities, of $285.1 billion, up $16.2 billion from the previous quarter. About 94 percent of it was held overseas, the company said on its earnings call.

"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," Apple CFO Luca Maestri said on the call.

Maestri lauded the tax reform and said it has vested the company with additional flexibility from the access to the foreign cash.

"And in the past, we've been addressing this issue by having to raise debt as the cash was overseas," he said. 

Apple issued $7 billion in debt during the quarter, taking its total debt to $122 billion — $110 billion in term loan and $12 billion in commercial paper.

In a Jan. 17 release, Apple said it expects repatriation tax payments of about $38 billion.

Cupertino said it plans to invest over $30 billion in capital expenditures over the next five years and create over 20,000 new jobs through hiring at existing campuses and opening a new one.

See also: Apple Nears Trillion Valuation; Here's The Story Of The Company First To Break The Billion Mark

Fishing In The Debt Market

In February 2017, Apple raised $10 billion in debt through a nine-part bond sale of both fixed and floating rate notes, according to the final pricing term sheet it filed with the SEC.

Apple returned to the debt market in May 2017 with a six-part offering, raising $7 billion in the process.

The company tapped the debt market yet again in September 2017, issuing two-year fixed and floating rate notes, five-year notes, 10-year notes and a 30-year bond. The company raised $5 billion through the offering.

In November 2017, the company sold notes in six parts — $7 billion in total — to fund its stock buyback and dividends.

The purpose of the fundraising was invariably for funding Apple's shareholder return program, including stock buybacks and dividend payouts. In a few instances, the debt capital raised was also meant for general corporate purposes, including to pay off debt.

Apple first tapped the bond market in 2012, and since then its debt has ballooned from zero to $122 billion at the end of the 2018 Q1. 

Why The Preference For Debt?

If Apple had chosen to repatriate its cash and liquid assets held overseas using the earlier applicable tax rate, it might have had to shell out taxes at a 35-percent rate. With Apple enjoying a low-risk Aa1/AA+ bond credit rating, raising funds through bonds is a relatively cheaper option.

The terms of the $7-billion debt offering Apple announced in November are as follows:

  • $1-billion, 1.8-percent notes due 2019
  • $1-billion, 2-percent notes due 2020
  • $750-million, 2.4-percent notes due 2023
  • $1.5-billion, 2.75-percent notes due 2025
  • $1.5-billion, 3-percent notes due 2027
  • $1.25-billion, 3.75-percent notes due 2047

The economics of the debt work out better for Apple when the earlier 35-percent repatriation tax is taken into consideration.

The End Uses For Repatriated Profits 

Not all companies are intending to pour repatriated profits back into their businesses, the primary reason for which the tax holiday was contemplated, according to Statista, which quoted a Bank of America Merrill Lynch survey. 

About 65 percent of the companies surveyed said they would use the cash to pay down debt. This sounds logical, given interest rates are expected to rise through 2018.

Infographic: How U.S. Companies Would Spend Repatriated Foreign Cash | Statista

Source: Statista

Share repurchase was stated as one of the end uses by 46 percent of companies, and M&A was named by 42 percent of the companies. Capital expenditure comes only fourth, with 35 percent of the companies surveyed suggesting they would use the overseas cash horde for investment.

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