As an Apple (AAPL) shareholder, am sick of my company dodging the tax man. At the end of last quarter, AAPL had $137.1B in cash and equivalents, up $15.9B from the prior quarter. $94.2B of that cash is held abroad in order to avoid paying taxes. This is the most rapidly growing portion of the balance sheet, increasing by $11.6B from September to December. While this accounting switcheroo makes the company look better in the short run by lowering the effective tax rate and increasing earnings, this mountain of cash is extremely capital inefficient. In this article, I will argue that in its obsession with avoiding taxes, AAPL is neglecting its duty to maximize shareholder value.
Cash under a Mattress
In the current interest rate environment, AAPL's cash pile is similar to hiding cash under a mattress. There is just no way for AAPL's cash to do much better than inflation unless it piles on credit or duration risk in its bond portfolio. I don't like this situation at all. If I wanted to put my money under a mattress, open a savings account or buy long duration or high yield bonds, I would not have bought APPL stock. I do not want to own a bond or money market fund with a tech company attached.
Having Your Cake
A lot of people agree with me that cash hoarding is not a wise capital allocation strategy, but balk at the idea of paying taxes. Various schemes have been floated to unlock the value of foreign-held cash without paying taxes, including taking on debt to fund returns of capital or David Einhorn's proposal to issue perpetual preferred stock.
These two workarounds are missing the forest for the trees. They do nothing to move the cash from foreign to domestic accounts while avoiding taxes. Instead, they focus on financially engineering domestic cash while leaving foreign cash alone. I don't want foreign cash to be left alone because such thinking got AAPL into this problem in the first place: foreign cash is nearly $100B, and is growing at the rate of $30B-$40B per year. Neither of these strategies will avoid the scenario of AAPL having $200B in foreign cash in 2016.
Rip off the Band-Aid
Although it is painfully obvious, Wall Street has yet to come around to the one solution to AAPL's cash problem: bring the money back, pay taxes, and give the remainder to shareholders via dividends or buybacks. It is that simple. Some may hold out hope for a tax holiday, but I have little faith in Washington to pass a budget let alone push through politically unpopular tax give-aways during a period of belt-tightening.
A few have argued that AAPL wants to keep some cash as a rainy day fund or to make a big acquisition. This is a red herring. Both of those objectives can be easily met while wiping the slate clean on foreign held cash and holding on to the $42.9B held domestically. This is especially obvious considering that the company is generating nearly $1B per week in free cash flow. Keeping profits in foreign bank accounts is a tax dodge, plain and simple.
I Want my Money Back
I would like to close out my Irish bank account held in trust by AAPL. It is my money after all, and I think that AAPL stock is pretty cheap right now, so I'd like to buy more. There are two ways for that to happen, a special dividend or stock repurchases. Here's how each would play out:
Subtracting 35% in corporate taxes from $94.2B, shareholders can withdraw up to $61.23B from their Irish bank accounts. At a float of 939,058,000 as of Jan 11, 2013, that is $65.20 per share. With AAPL trading at $430, this could fund a 15.2% special dividend, which I would reinvest. Or, the float could be reduced by 15.2% if shares could be bought back at current prices (my stock is in an IRA, so I have no preference between dividends and buybacks). Not a bad way to get a much bigger slice of the AAPL pie.
But wait, what if paying taxes is viewed by the market as value-destroying? Market participants could take this to mean that AAPL has few good ideas for reinvesting its cash in the business. Or, they could be upset by the fact that dubious valuation metrics such as "p/e minus cash" may look a bit less attractive. I'm skeptical that the market will react this way, but as a long-term investor, I'd hope it would.
Lets say that the $33B in taxes paid under my proposal was shaved off the market cap after it was initially announced to the public. Now I'd be able to buy AAPL at $395, so the transaction would mean that I would increase my share count from the reinvested dividend or relative stake in a shrinking float by 16.5%. I would be significantly increasing my holding in one of the world's most recognizable and desired brands at a p/e ttm of less than 9 and a yield of 2.7%. AAPL skeptics may think this is a bad deal, but their opinions don't matter. Current AAPL longs like myself think the company is cheap, so they should jump at the chance of adding to their positions by closing out a low-yield Irish bank account they don't even want.
Apple's cash problem is a tax problem. In its desire to avoid taxes and increase short-term earnings, Apple has accumulated a gigantic pile of cash that is earning essentially nothing. It should pay its taxes and return the bulk of its cash and free cash flow to shareholders. Financial commentators trying to avoid this basic reality are like stock investors who avoid fundamentals and base their decisions on the tax code. As we all know, the tax code makes just about zero sense. As such, it should not determine capital allocation. Taxes are one component of the investment decision process, but other things matter as well. Just ask someone who bought a company like Exxon (XOM) in 1950. Promptly paying taxes and regularly returning the remaining cash to shareholders has meant handsome returns for patient investors. AAPL should do the same. It will eventually have to pay taxes on its zero-yield foreign cash, and might as well do so while the stock is depressed so that investors like me can increase our stakes in one of the world's great businesses.