Investors in Apple (NASDAQ:AAPL) and other technology companies like Google (NASDAQ:GOOG) (NASDAQ:GOOGL), Cisco (NASDAQ:CSCO), and Qualcomm (NASDAQ:QCOM) are well aware these companies are very cash rich. However, a lot of their money is offshore to minimize their effective tax rate. Under U.S. law, repatriating this money is very expensive with a tax rate of 35%. As a consequence, this money is effectively trapped overseas and cannot be used to buy back shares or pay down debt. This is why companies like Apple and Cisco are borrowing to fund their capital returns despite having a gross cash position of $150 billion and $50 billion respectively (Apple's financial and operating data available here and Cisco's is here).
These technology companies would love nothing more than to be able to return cash to the U.S. without paying such a prohibitive tax rate. This money could be used to fund capital returns, investments, and domestic acquisitions, all of which could be good for current shareholders. It now appears that there is a significant probability of a repatriation tax holiday, which would make it possible to return money to the U.S. This could be a catalyst to move tech stocks like Apple even higher.
On Tuesday, Republican Senator Rand Paul said on CNBC he was finalizing a deal with Democrat Majority Leader Harry Reid on a tax holiday that would see the rate fall below 10% for three years (details available here). Typically, Republicans have been supportive of a holiday while Democrats have opposed one. However, there is reason to believe Paul and Reid can actually reach a deal. With this bipartisan coalition of very powerful senators, final passage in the Senate and House would be all but assured. Deadlines often spur action, and the U.S. faces a serious cliff this summer that could spur such a deal.
By the end of this summer, the transportation trust fund will run dry, meaning the federal government will stop funding construction projects on major highways across the nation. This would obviously cause significant chaos and temporarily sideline thousands of construction workers, which would slow an already sluggish economy. The windfall from a tax holiday will be wrapped into the transportation bill, which will fund the shortfall in the trust fund for several years. Currently, $2.1 trillion sits overseas, and a 5-10% rate could spur companies to bring back at least half of the money, bringing in $75 billion to the government. This deal helps the Democrats fund infrastructure investments while Republicans get a tax holiday.
Obviously, this deal is not yet law, but with Paul and Reid agreeing to a basic framework that benefits both sides politically, there is a significant probability this deal does become law. Such a deal would put tremendous pressure on companies to bring back money and increase capital returns. Assuming a tax rate of less than 10%, companies can bring back money that is earning nothing and use it to pay dividends and buy back shares in an accretive fashion. In particular, Apple could be a major beneficiary of this law.
For years, Apple has been criticized for its massive cash position, which lead Carl Icahn to buy a stake and agitate for a massive repurchase program. While he never launched a proxy fight, Apple has increased its capital returns. By the end of calendar 2015, Apple now plans to return $130 billion with $90 billion in buybacks. Thus far, it has already returned $66 billion. Apple could bring back upwards of $100 billion in foreign cash, which would be over $90 billion after taxes. At the same time, the company continues to generate over $40 billion in cash flow per year.
With an ability to bring cash back, Apple could stop issuing debt to fund capital returns, which cuts interest expense. It could also significantly accelerate its capital return program. With a repatriation deal, Apple could afford to add $70 billion to its buyback and dividend plan over the next 18 months. A buyback of that size would increase earnings by over 10% by so dramatically cutting the share count, which I believe would help shares pierce $100 (or $700 pre-split) and send Apple back past all-time highs. Now, there is no guarantee that Apple increases its buyback, but I expect investors like Icahn to agitate, and the company would almost certainly bring cash back and return it over time, otherwise the money would continue to languish overseas. A repatriation deal will likely accelerate capital returns.
Investors have been waiting for a new product to push shares higher, but on Tuesday, investors may have gotten a different catalyst, a possible deal in Washington that would unlock billions in money that is trapped overseas. This deal would help all companies that have a lot of money trapped like QCOM, CSCO, and GOOG, but AAPL with its truly outsized cash position would be the prime beneficiary. The Paul-Reid deal gives the company the chance to fix its capital structure by using cash to buy stock and significantly cut the share count to accelerate EPS growth. I expect a deal to push AAPL past $100 and would recommend buying on this news.
Disclosure: The author is long QCOM, CSCO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.