by Will Ashworth | April 29, 2014 6:00 am
Apple (NASDAQ:AAPL) stock jumped 8% April 23 on the news it was upping its stock buyback from $60 billion to $90 billion as part of its commitment to return $130 billion to shareholders by the end of 2015.
That’s very good news for Carl Icahn, who said he agrees completely with the Apple buyback.
To fund the buyback, AAPL is selling $17 billion in debt sometime later this year in both domestic and international markets. It will be the second consecutive year it has gone to the debt markets for cash after being debt-free since paying down $300 million in fiscal 2004.
Last year, AAPL saved an estimated $9.2 billion in taxes using debt instead of overseas cash. At the time, Moody’s vice president Gerald Granovsky called it “a no-brainer.” No doubt he feels the same about this year’s raise.
There’s only one problem.
While this might be good for Apple stock in the short term, it’s certainly not any good for American taxpayers. And furthermore, in the long term, it’s arguable how much value the Apple buyback provides Apple stock.
In fact, when it comes to buybacks, investors should always be careful what they wish for. Here’s why.
By the time AAPL sells its $17 billion in bonds, America (that’s you) will be out more than $18 billion in taxes. Wait, though — there’s more. Apple’s annual interest expense on last year’s bond sale is about $308 million. The buyers of those bonds got hosed, making Warren Buffett look pretty smart for passing on the offering due to low yields.
Although this year’s $17 billion sale could involve higher coupon rates it’s still unlikely that Berkshire Hathaway (BRK.B) will have any interest. Add another $308 million in annual interest for this year’s offering, and AAPL is saving itself $215 million in annual taxes through interest expense deductibility. Its $3 billion in 3.85% notes due 2043 could produce tax savings of as much as $1.2 billion over 30 years. However, that’s unlikely given that AAPL will probably have redeemed much of it by then. Nonetheless, this hypothetical worst-case scenario is an eye opener.
I’ve said it before — Apple’s stance on taxes is un-American. This might not matter to investors of Apple stock, but it should concern average Americans because it’s just plain wrong.
Apple Insider contributor Daniel Dilger makes the argument that Apple’s $44 billion buyback over the past four quarters has directly contributed to the $100 million increase in its market cap over the same period. He goes on to suggest improving fundamentals also had a part to play in Apple stock moving up 29.2% year-over-year. It’s a very reasonable argument.
Just look at the numbers…
Apple’s fundamentals in Q2 2014 saw revenues increase 5% year-over-year, gross margins improved by 180 basis points, and earnings per share increased 15.2%. That rather good. However, when comparing Q2 2013 to Q2 2012, where revenues increased 11.2% year-over-year but gross margins declined 990 basis points and earnings per share were reduced by 18%, it’s acutely obvious how much profitability has improved year-over-year.
At the end of the day, AAPL net income in Q2 2014 increased 7% year-over-year. If you add back the 80 million shares it repurchased over the past four quarters, its earnings per share would have increased by 8% rather than the 15.2% reported. As I see it, Dilger’s essentially arguing that AAPL spent $44 billion to get 7.2 percentage points in additional EPS growth, which he believes translates into an additional $100 billion in market cap.
It’s a good argument in the short term. However, it falls apart over the long term.
Between 2004 and 2012, the number of AAPL shares outstanding increased by 22% or 170 million. In that time, its net income grew from $276 million to $41.7 billion. It wouldn’t have mattered a lick if the number of shares outstanding increased by 10 times this amount. Apple was making so much money, investors were buying Apple stock by the bunch.
As AAPL matures, this is going to become harder to accomplish. Eventually, it’s going to have to decide whether it’s prudent to continue leveraging the balance sheet simply to avoid paying additional taxes. At a 35% tax rate, the current $132 billion in overseas cash would cost AAPL $46.2 billion to bring it all home. On a per-share basis, that’s $53.63 or about 9% of its stock price as of April 28. And while handing over more than an entire year’s worth of profit to the U.S. government is hardly a welcoming thought for most shareholders; it’s not the craziest idea in the world.
To me, what’s crazier is borrowing $34 billion — or $68 billion or who knows what — simply to dodge taxes. A long time ago, when I was selling investments rather than writing about them, a wise person told me you always consider an investment on its merits and not because of the tax savings.
From where I sit, AAPL should only do buybacks with the money it has, and if it doesn’t want to repatriate the cash it shouldn’t consider them.
Is new debt good for Apple stock? Not in the long term, not even a little.
As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.
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