We all know about companies holding large amounts of offshore cash and keeping profits overseas. What you may not realize is the sheer size of this practice. Recently, Bloomberg published an article talking about the huge increase in offshore profits. Today, I'll cover the news and explain what it means for some of the biggest names.
The latest report:
Bloomberg states that some of the largest US based companies increased their untaxed offshore stockpiles by $183 billion over the past year, a rise of 14.4 percent. The total amount held by these 83 companies, yes, just 83 companies, was $1.46 trillion.
The reason for this practice? Well, here's what the article states.
The build-up of offshore profits -- totaling $1.46 trillion for the 83 companies examined -- is increasing because of incentives in the U.S. tax code for booking profits offshore and leaving them there. The stockpiles complicate attempts to overhaul the tax system as lawmakers look for ways to bring the money home and discourage profit shifting.
The ability to defer U.S. taxes until profits are brought home, the ease of shifting profits to low-tax countries and the world's highest statutory corporate rate have all contributed to the growing stockpiles outside the U.S.
A report last year by JP Morgan analysts estimated that all US companies had about $1.7 billion overseas. Bloomberg's data suggested that the 83 companies examined had 75% of last year's total, meaning that we could be up to about $1.9 billion, or maybe even over $2 billion, by now.
Examining a few top names:
Obviously it would take a lot to examine all 83 companies, and it might be repetitive to discuss even a dozen. So today, I'm going to focus on five names, three of which I write about frequently on this site. The names I will cover are Apple (AAPL), Google (GOOG), Microsoft (MSFT), General Electric (GE), and Las Vegas Sands (LVS). While these five names are tech heavy, I have a little more experience in some of these, but I will also highlight each for a different reason.
Let's start with Apple, because it is the largest name (by market cap) that I'll talk about and the name I write about the most. According to the Bloomberg article, Apple had permanently reinvested overseas earnings of $40.4 billion, and an overseas cash pile of $82.6 billion. That was as of September 29, 2012, and we know from Apple's latest results that Apple's overseas cash pile was up to approximately $94.2 billion at the end of 2012. Given that we are almost two and a half months into 2013, that number is likely close to $100 billion by now.
The interesting item to consider with Apple is one I discussed in my most recent article. Even though Apple has all that money parked offseas, they have been accruing taxes for some of those profits, according to Toni Sacconaghi of Bernstein Research. Sacconaghi states that Apple would be able to bring back about $42 billion into the United States. The key here is that Apple would still have to pay the cash amount of the tax, however, it would not affect their financial statements (in terms of tax rate, net income, eps). Apple's reported effective tax rate in fiscal 2012 was 25.16%. The tax rate might not seem like much, but if Apple's tax rate was just 1% higher (26.16%) in that fiscal year, it would have impacted earnings per share by 60 cents. Apple's tax rate in Q1 of fiscal 2013 (and their guidance for Q2) was 26%. The higher tax rate does have a slight impact on earnings per share growth, something key in Apple's stock price plunge.
Apple has come under fire recently, as most people know, because investors want the company to start returning some of that $137 billion plus to them. Disregarding the two-thirds overseas for a moment, if Apple doesn't have any better place to put it, why not return it to shareholders? Apple is paying a decent dividend currently, 2.46% annual yield as of Friday's close, and buying back stock, but it doesn't seem to be enough. I don't know anyone that isn't expecting Apple to increase its dividend this year, and many expect a substantial raise.
I am bringing up Google because of the five names I'm discussing, it is the only company not returning cash to shareholders in some form. Google does not pay a dividend, and has stated the following on Page 26 of its most recent 10-K filing:
We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings and do not expect to pay any cash dividends in the foreseeable future.
Google also is not buying back stock. In 2012 alone, the outstanding share count (between both Class A and B shares) rose by nearly 5 million shares to just under 330 million. That number will continue to rise indefinitely unless Google changes its policy on cash.
Google shareholders continue to be further diluted each quarter from executive options. This dilution, which over longer periods of time is more significant, can have a dramatic impact on earnings per share. For the full year in 2012, this dilution negatively impacted earnings by share by 50 cents. Once Google starts buying back stock, this trend might reverse, but until they, further dilution will pressure earnings per share. Google probably won't buy back stock, unless they bring some of this foreign money home.
The Bloomberg article also states that some companies, including Google, have been asked to "assert that they have enough liquidity in the U.S. to justify their contention that the offshore money will stay overseas indefinitely." According to the Bloomberg article, nearly two-thirds of Google's $31.4 billion in liquid holdings were held offshore as of the latest filing.
Google shares have rallied strongly in recent months, going from around $550 to $830 over the past year or so. We saw a similar run in Apple, and then that stock crashed. Should Google's stock start to crash, we might see shareholders in Google start demanding some returns of cash.
Microsoft makes my list for a couple of reasons. First, it is third on Bloomberg's list for offshore holdings. The second part is in reference to the liquidity issue I mentioned above in the Google section. Of the major tech names I follow, Microsoft appears to have the smallest percentage of cash inside the US, when looking at cash and short-term investments. Unlike Apple, names like Google and Microsoft only provide a foreign number for their cash and short-term investments balance. If these companies have any long-term investments, there isn't a number for how much is held overseas. Apple provides a total for everything.
I recently compared a few of these cash hoarding names. Of the $68.3 billion or so in cash and short-term investments on the balance sheet, Microsoft had roughly $61 billion outside the United States. That means that the company had just over $7 billion inside the US.
It would appear that Microsoft's financial flexibility may be limited, but it's actually the opposite. Microsoft pays a dividend that yielded 3.29% as of Friday's close, and in their fiscal second quarter (ending 12/31/12), they bought back over $1.6 billion in stock. Imagine what Microsoft, Google, or Apple could do with even a small portion of these foreign funds back inside the United States.
I brought up GE because it leads Bloomberg's list again. GE has added another $6 billion offshore, bringing their estimated total to $108 billion. GE brings up the tax issue on Page 30 of its most recent 10-K.
Income taxes on consolidated earnings from continuing operations were 14.4% in 2012 compared with 28.3% in 2011 and 7.3% in 2010.Our consolidated income tax rate is lower than the U.S. statutory rate primarily because of benefits from lower-taxed global operations, including the use of global funding structures. There is a benefit from global operations as non-U.S. income is subject to local country tax rates that are significantly below the 35% U.S. statutory rate. These non-U.S. earnings have been indefinitely reinvested outside the U.S. and are not subject to current U.S. income tax. The rate of tax on our indefinitely reinvested non-U.S. earnings is below the 35% U.S. statutory rate because we have significant business operations subject to tax in countries where the tax on that income is lower than the U.S. statutory rate and because GE funds the majority of its non-U.S. operations through foreign companies that are subject to low foreign taxes.
GE is a bit different from the tech names above because it has several different lines of business spread out across the globe. Also, GE has GE Capital, a financial services business, which provides another complex layer of tax issues. This isn't an article about tax structure, so I won't go into all of the details. The important part here is that GE has reinvested a significant amount of earnings outside the US, and leads Bloomberg's list yet again.
Las Vegas Sands:
I'm bringing up the casino company because Bloomberg discusses something special about this name. The company in 2012 repatriated $1.37 billion tax-free because it had enough foreign tax credits. How does this happen? Bloomberg states:
U.S. companies receive foreign tax credits for payments to other countries, meaning that they can bring home previously taxed earnings with little residual tax owed to the U.S. They also can defer the U.S. tax until they bring the profits home.
If Las Vegas Sands continues to generate enough credits, they probably will continue to repatriate these monies. According to Bloomberg, Sands' accumulated earnings declined from $5.6 billion to $4.3 billion. Shareholders of this company are certainly being rewarded. The company recently raised its quarterly dividend from $0.25 to $0.35. That's a 40% raise in the dividend, which now yields 2.67% on an annual basis as of Friday's close. The company also gave back to its shareholders with a large special dividend in December 2012.
Why this matters for long-term investors:
By now, everyone knows about this practice, and most likely, we will see limited examples of companies bringing the money back home unless we get a change in US tax policy. Las Vegas Sands was an example of a company that was able to bring money home, and investors were rewarded with dividends. There are a couple of issues for long-term investors that I'd like to discuss today.
Let's start with an example involving Apple if the money was brought home, and we'll assume Apple brings back $20 billion (after tax or counting a tax holiday). Apple could immediately use that money to buy back about 5% of its outstanding stock at current prices. Not only would that be a signal to investors that Apple believes its stock is too low, but it would also help to improve earnings per share. Apple investors have been worried about lower margins sinking earnings, and the current estimate for earnings per share this fiscal year of $44.52 implies almost no growth from the $44.15 in the prior fiscal year (ignore the extra week for a moment). Taking away 5% of the outstanding shares, and Apple's EPS would be roughly $46.75. That would represent about 5.9% growth, which would be a lot higher than the 0.8% growth Apple analysts currently expect. Additionally, reducing the share count by roughly 47 million shares would save Apple about $500 million a year in dividend payments (using the current $10.60 rate). That saved money could be used to further buy back stock, or could help push the dividend even higher. If you don't believe bringing this money home is beneficial, please ask Las Vegas Sands shareholders what they think. With so many concerns over Apple's growth driving down the stock price, even an earnings growth rate in the mid single digits would be vastly superior to flat growth.
On the flip side, there are two negative items for shareholders, one of which I discussed above involving Google. With a rising share count, not only are Google's investors being diluted each quarter, but earnings per share are hit as well. I mentioned above that the rise in Google's share count over the past year cost investors 50 cents on earnings per share during 2012. Now, if you go back to the share count from 2009, the impact is up to $1.30 per share. As of Friday's close, Google shares were trading at 25.75 times trailing twelve month GAAP earnings (the 2012 earnings). However, if Google's share count was at 2009 levels, the multiple would have been 24.75 times. One full point doesn't seem like much, but it is when you consider Apple was trading at just 9.8 times trailing twelve month earnings as of Friday's close.
The other issue is liquidity. I mentioned above that the SEC has asked a few companies to prove that they have enough funds inside the US to operate. By parking most of their funds offseas, these companies are almost operating on the edge. What happens if they need some money right away? Well, there are two scenarios. The most likely one is that they raise some money through debt. While rates are low right now, the company still would be paying interest, which lowers a company's earnings and profit margins going forward. The other choice would be to bring back some of those foreign funds. Right now, that would be a double negative. The company would have to pay the tax, plus for those that haven't been accruing taxes like Apple, it would show up in the income statement. Either way, companies operating on the edge would have a negative outcome if they need funds.
I'm not here today to criticize or debate the US tax code, but I agree with the Bloomberg premise that the current system provides an incentive for companies to keep profits overseas. Companies are now piling up more profits and cash overseas, with almost $2 trillion in accumulated offshore profits. I keyed on five names above where these issues are extremely prevalent. Some of these names pay dividends and buyback stock, even with low amounts of cash inside the United States. The point of the matter is that if these funds were back inside the United States, you probably would see higher dividends and more stock buybacks.
Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.