To summarize, Apple’s cash hoard of $76 billion currently represents 71% of total company assets. Apple’s policy of hoarding this exorbitant amount of cash is both increasing the firm’s weighted average cost of capital (WACC) and lowering the firm’s overall return on invested capital (ROIC), thereby destroying value.
Some critics of my argument have speculated (none have cited figures) that AAPL is hoarding cash as part of a profitable tax avoidance strategy. Incidentally, this tax avoidance argument has been made very forcefully at the Motley Fool here and here.
As it turns out, the tax avoidance argument has some basis. According to Apple’s most recent 10Q statement, $47.6 billion out of $76.2 billion, or 62.5% of Apple’s cash and marketable securities were held by foreign subsidiaries (p.33).
Assuming that the company’s effective tax rate remains at the current 24%, this means that any project that would involve repatriation of those funds would have to clear a “hurdle rate” of at least 24%.
HIGH HURDLE RATE?
A 24% hurdle rate seems very high at first blush. However, this 24% return figure - which equates to $11.4 billion - should not be conflated with an annual rate of return figure. The 24% figure is an one-off figure that equals $11.4 billion in net present value (NPV).
The implication? Whatever project AAPL invests in that involved the repatriation of those funds would need to produce an NPV that equaled or exceeded $11.4 billion over the life of the project.
Another way of putting it is that the economic value added (EVA) of a project that invested $36.2 billion ($47.6-$11.4) needs to be at least $11.4 billion.
How difficult is that? Let us assume that AAPL invests $36.2 billion in a project or projects with a forecasted average life of 20 years. What is the rate of return above AAPL’s current return on those assets that would be needed to produce an EVA of $11.4 billion off of the initial investment of $36.2 billion?
The answer? 1.66%
IT’S CHEAPER TO PAY TAXES
Assuming that AAPL is currently earning 0.5% per annum on its cash hoard, AAPL would have to find some project or projects that would generate an annual return of 2.16% (1.66%+0.5%) for 20 years. (Note: this calculation assumes capitalization).
Another way of putting it is that any project that would yield 2.16% for 20 years would create more value to AAPL shareholders than hoarding this $47.6 billion in cash overseas (granting the full tax advantage of hoarding).
Or yet another way of putting it is that assuming that AAPL could find projects yielding more than 2.16% per annum, it is cheaper for AAPL to pay the federal income taxes on the $47.6 billion compared to hoarding the cash.
CAN APPLE FIND PROJECTS THAT WOULD ADD VALUE OF $11.4 BILLION?
I won’t speculate about returns on investment in M&A. I’ll let others do that.
However, I do have one project which I am very certain would yield a return to shareholders of much more than $11.4 billion: Institute a dividend.
$11.4 billion is equivalent to 3.28% of AAPL’s current market capitalization.
Can anybody seriously doubt that AAPL’s valuation multiples - such as its currently pathetically low PEG of around 0.55 (lower than that of just about any large cap stock in the US) - would expand sustainably far beyond this 3.28% threshold if AAPL instituted a dividend?
I believe that AAPL could conceivably double or more than double the value of the company if it instituted a large dividend.
$36.2 billion (this is what would be left over of the $47.6 billion after paying the tax) would allow APPL to increase its implied dividend yield by 200 basis points (based on the current price) for five years in addition to whatever free cash flow AAPL decided to distribute to shareholders.
Upon detailed analysis, the notion that AAPL is adding value to shareholders by employing a tax avoidance scheme that involves the hoarding of massive amounts of cash in foreign subsidiaries turns out to lack validity.
It is true that AAPL would be subjected to taxation if it repatriated those foreign earnings.
However, it is also true that there is an enormous opportunity cost involved in hoarding that cash which needs to be compared to the value of any potential tax savings.
The clear conclusion is that assuming that Apple could find projects that yield over 2.16% per annum on the capital that the company currently has stashed in accounts held by foreign subsidiaries, AAPL is destroying value by hoarding this cash.
The tax avoidance benefits of hoarding the cash in foreign subsidiaries is insignificant compared to the value that AAPL that AAPL is destroying (foregoing).
What should Apple management do? AAPL should either invest this money in productive projects that add value to its core business or it should return these profits to shareholders in the form of dividends in order to sustainably raise the value of the stock and lower the stock's volatility.