Apple's (AAPL) recent bond issue, the largest such issue in our nation's history, rightly drew an enormous amount of press. This is a clear departure from the Steve Jobs' culture of hoarding cash and eschewing debt in favor of internally generated cash from operations to fund the business. However, it was another departure from the late Jobs' mantra, that of paying a common stock dividend, that brought about this change. Indeed, Apple has stated it is using the proceeds of the bond issues to pay the dividend and/or buyback shares. This article will take a deep look into the cash flows of the bond issues, after-tax costs and savings that will accrue from the financing move.
First, it is important to understand exactly what Apple issued. The company issued a total of $17 billion in bonds in six different tranches, four with fixed interest rates and two with floating rates based upon LIBOR. In addition, maturities range from three years to thirty years. For my analysis, I had to make certain assumptions: 1) no early repayment of the principal 2) interest expense amounts are prorated for partial years in 2013 and respective maturity years 3) assumed the floating rate bonds bear the same interest as their fixed rate counterparts of similar maturities 4) constant tax rate for all years of 26% (Apple's approximate historical rate) and 5) none of the bonds refinanced upon maturity.
To begin, we should take a look at the yearly cash flows that have been promised by Apple with these issues.
We can see that in the first three years, including 2013, Apple only needs to worry about the after-tax outflows of interest payments. In this case, they hover around $300 million annually. This is a lot of cash for most corporations but it represents roughly two days' worth of operating cash flows for the Cupertino giant. In 2016, when the first two tranches of debt mature, Apple will still only be responsible for less than $3 billion in total cash outflows to service the bonds and retire the first two tranches. 2018 is the largest single year of cash outflows as two more tranches mature, totaling just over $6 billion including after-tax interest payments. 2023 sees the largest single tranche mature, requiring total cash outflows of just under $6 billion that year. For the succeeding 20 years, Apple is only responsible for the interest payments on the 30 year tranche of debt, or approximately $85 million per year. Finally, in 2043, the last remaining tranche matures for total cash outflows of just over $3 billion.
To put these numbers in context, Apple generated just over $50 billion in operating cash flows last year. While no one is expecting Apple to produce that much cash again this year, it will likely be comfortably over $40 billion, meaning its ability to cover interest and principle payments is virtually unmatched.
Next, we can break down how much it will cost Apple to service this debt over the tranche's respective lives and the total nominal amount of cash that is due.
From this graph, we can see that, even over thirty years, the after-tax cost of interest payments for Apple will only total something like $4 billion (columns, left scale). This is astounding considering the amount of money that is being borrowed. Record low interest rates and Apple's stellar financial condition allow the company to borrow at ludicrous interest rates. Likewise, the company's total, cumulative cash outflows as result of after-tax interest payments and principal repayments are shown on the right scale by the red line. We can see that initially, outflows are quite low and ramp up only when the bonds begin to mature. By my calculations and schedules, Apple has promised about $20.8 billion in nominal outflows over the next thirty years. This implies the nominal total after-tax cost of the debt issuances is $3.8 billion.
Now, the most important part of this analysis is what Apple is going to do with the money. For this analysis, we are going to assume Apple borrowed this money to repurchase shares.
If we assume Apple uses the proceeds exclusively for share repurchases, the company will save $12.20 per year in dividend payments that would otherwise be due. Therefore, we can calculate the amount of money that could be saved by simply repurchasing stock. This chart assumes a steady $12.20 dividend payment for all thirty years and that all $17 billion in proceeds are spent virtually immediately to repurchase shares. Of course, this is unlikely to happen but as long as the purchases are made within the next couple of years, the difference in savings is negligible.
What we see is striking; Apple is slated to save over $14 billion in dividend payments over the next thirty years even assuming it never raises the dividend again. Of course, Apple is likely to raise the dividend yearly up to a point but to be conservative, we will assume this will never happen. Indeed, this chart shows that the cumulative amount of after-tax interest payments will total less than $4 billion but the dividend savings alone should be something like $14 billion; I would say, by this metric, the financing move was a terrific success that will pay off for many years.
Finally, if we assume Apple raises its dividend by just 3% per year, we can see the savings on dividend payments increase almost exponentially.
The cumulative after-tax cost (blue line) and cumulative dividend savings (red line) are exactly the same data as the previous chart. However, I've added the cumulative dividend savings assuming Apple continuously increases its dividend at 3% per year (green line) in order to demonstrate just how much money Apple could be saving by making this financing move.
While a constant dividend rate shows Apple saving $14 billion over the thirty year life of the bond issues, assuming a 3% dividend raise yearly means Apple could save as much as $23 billion. If this were to occur, it would mean Apple was investing less than $4 billion in order to profit $23 billion over thirty years.
Obviously, I am in favor of Apple's financing move. I love the way the math works out for shareholders as it will save Apple billions upon billions of dollars over the next few decades. Indeed, the best part is the willingness of management to step outside the box Steve Jobs put the company in when it comes to corporate finance. Jobs didn't participate in creative ways to use cash due to a brush with bankruptcy in the 90's. While Tim Cook has taken a lot of heat for various things since he took over, he should be praised for finally taking Apple into the 21st century when it comes to the way cash is deployed. As the growing cash hoard was a sore point for many investors, it is now an asset that is powering the shares higher.