It is one of the most widely covered stories in the market today, that of Apple (AAPL) and its massive cash hoard that is trapped outside of the United States. The debate over the strategy Apple should employ with regard to its cash balance received a jolt when Apple announced in its latest earnings release that it would embark on a massive stock repurchase plan in addition to increasing its dividend. Apple will partially fund these actions through the issuance of corporate debt. By issuing debt, Apple would be able to avoid paying over $9B in US corporate income taxes if you assume that the entirety of the stock repurchase was funded with cash currently held outside the US that would have to be taxed in order to be used as part of the share repurchase program.
In the next chapter of this story, Apple CEO Tim Cook is scheduled to testify in front of Congress this week. The topic will be the US corporate tax structure, and Mr. Cook will apparently propose a dramatic simplification to the current corporate tax structure in the US. This type of proposal from the CEO of a US-based company with massive overseas cash is nothing new. John Chambers, CEO of Cisco, has been lamenting the US corporate tax structure for years, going so far as to threaten to move jobs overseas if the tax structure is not reformed. However, the CEO of Apple taking a measured approach to corporate tax reform just might provide the catalyst needed for meaningful tax reform to move into the realm of reality.
The investment implications for Apple, regarding the corporate tax structure in the US, are very straightforward. Any change, even a minimal reduction to the domestic corporate tax rate or rate associated with foreign cash being repatriated, will immediately increase the future earnings outlook for Apple. Additionally, as the company with the largest foreign cash hoard, Apple stands to benefit more than any other US corporation. Thus, it is a positive for investors to see Tim Cook and Apple taking the lead in the push for corporate tax reform. Ultimately, the downside related to Apple making a public campaign for corporate tax reform is limited. Most analysts already assume that foreign cash held by Apple will at some point either be taxed when it is repatriated, or is heavily discounted in any valuation models due to its limited use for the company. If Apple is able to effect change, the upside is that future earnings expectations would be materially increased.
Scope Of Foreign Cash Held By US Companies
Just looking at the companies that make up the S&P 500 index, it is estimated that foreign cash holdings are over $1.5 trillion at this time. These companies, for the most part, refuse to repatriate this cash to the US because they are loathe to pay the 35% or greater income tax that would be due in conjunction with bringing this cash back to the US. So the cash sits in some foreign country, earning next to nothing as the companies play a game of chicken with the US government. These companies wait, because the precedent exists for the government to create at the very least a temporary tax break or holiday as was done in 2004. At that time, companies were allowed to repatriate their cash holdings and only pay a 5% tax on the cash, compared to the 35% they otherwise would have had to pay.
The problem with this approach is that it penalizes those companies that do repatriate their foreign cash holdings, such as Texas Instruments (TXN). At the same time, it encourages technology behemoths such as Apple to hold out hope that another tax holiday will emerge. The US government has only itself to blame as its past actions have dangled the carrot, and these companies now patiently wait and lobby to bring cash back to the US at a significant discount.
Why Apple And Tim Cook Could Change The Debate
Apple is the 800lb guerrilla in the debate over foreign cash held by US companies. It is estimated that over 70% of Apple's cash balance, over $100B, is held outside of the US. This $100B would be subject to the 35% tax rate were it to be brought back to the US.
Tim Cook has an opportunity to frame the debate around taxes in a way that emphasizes allowing US companies to remain competitive in a global economy. Although he may be in Washington so that the circus commonly known as Congress can berate him for Apple's supposed tax avoidance, this is a seminal opportunity for Tim Cook to reframe the debate on corporate taxes. Nothing that Apple has done with regards to leaving its cash overseas or issuing debt to fund its stock repurchase program is illegal. Further, Apple is claiming the mantle as the largest corporate taxpayer in the US, paying close to $7B annually in corporate income taxes.
Steve Jobs seemed to eschew Washington, D.C., and politics in general. Tim Cook, while realizing it is impossible to replace his former boss, also seemingly realizes that embracing public policy offers the opportunity for Apple to play a leading role in reforming the US corporate tax code. Tim Cook has already made it clear that Apply is committed to investing in the US by bringing back manufacturing jobs that were previously sent overseas. As actions speak louder than words, if Apple continues to invest in the US, the ability for Tim Cook to hold court in Washington and sway opinion will grow.
The Importance Of The Debate For Apple
As it currently stands, most valuations of Apple assume that a significant portion of the $100B in overseas cash has no value to the company as it will simply be used to pay taxes when that cash is repatriated. Likewise, future cash generated overseas will continue to be a lion's share of the total cash that Apple generates. Any permanent change to the corporate tax code, making it more conducive to generating foreign earnings, will serve two purposes. In the short run, it will dramatically alter the debate on the valuation for Apple. The change could be as simple as the tax code being reformed, in just a slight manner, to encourage US companies to repatriate their cash. Unless those companies decide to sit on their cash in the US, versus a foreign country, the cash will ultimately find its way into the economy. Through dividends, increased domestic investments, or acquisitions, the possibilities of how that cash could drive economic growth in the US become almost limitless.
In the long run, if Tim Cook is able to effect change with regards to reforming the US corporate tax code, the outlook is immensely brighter as well. Apple and other companies will be able to run their businesses with a longer-term vision, not sitting on their hands waiting and hoping for a cash holiday to bring their cash back to the US. Just the simple concept of certainty around tax planning will benefit both US companies and the government coffers as well as the US economy.