An Insight On Cash Repatriation

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Includes: AAPL, GS, MS, MSFT
by: Paulo Santos

Summary

The upcoming cash repatriation flood has been seen as a kind of panacea for investment, R&D and even buybacks.

I disagree with that view, but this article is on another not-yet-touched consequence of repatriation.

The repatriation happening is likely to be a negative for a specific investment banking area.

One of the things that's expected from Trump is that he'll allow for repatriation of cash balances held in foreign lands at a low tax rate. Cash is held abroad by many companies simply because bringing it home would lead to it being taxed at regular US rates.

The thinking goes that bringing this cash home can lead to more investment, more R&D spending and more buybacks. Now, I disagree with this. The kind of company that keeps a large cash hoard abroad is not the kind of company which invests less or does less R&D because the cash is abroad. But that isn't really the theme of this article.

Instead, this article is born from the view that the companies which keep a large cash hoard abroad are not the kind of companies which refrain from buying back stock just because the cash is abroad. These are typically very credit-worthy companies. And they're acting in a low interest rate environment. So what do these companies typically do when they want to buy back stock in the US and the cash is nearly all sitting abroad? Oh, well, they simply issue debt in the US, and use the cash proceeds to buy back the stock.

The Apple (NASDAQ:AAPL) Example

Take Apple. Apple is an incredibly profitable company. Apple also does its share of tax planning. And Apple sells its high-margin iPhones all over the world. The end result from all of this is that Apple accumulated an ungodly amount of cash in foreign lands.

A little background. Back in the long-gone days of 2012, Apple had lots of cash in its balance sheet (~$121.3 billion, including long-term marketable securities) and exactly $0 in debt. The overwhelming majority of that cash, $82.6 billion, however, was held by foreign subsidiaries. Apple couldn't use that cash in the US without having it first suffer US taxation. It was then, that Apple decided to start an increasingly-aggressive buyback program, which would start in 2013.

Initially, that buyback program started modestly as a $10 billion authorization. However, that was quickly expanded to $60 billion in April 2013 and to $90 billion in April 2014. Since the buyback was going to take place in the US and it expanded to levels exceeding cash held in the US, quite quickly Apple needed to find a US source of funds. So Apple started borrowing to buy shares.

Fast forward to today, and Apple has $246.1 billion in cash in its balance sheet. But, due to the mechanism used to create cash in the US without repatriating it, it also holds $87.5 billion in debt for a net cash position of $158.5 billion.

Not Just Apple

Naturally, the mechanism described above didn't just happen at Apple. Many other companies in the same situation, like Microsoft (NASDAQ:MSFT) and many others, also did the exact same thing. They bought back stock and issued debt to have the necessary US-based cash to purchase said stock.

Therein Lies The Insight

There was, obviously, a lot of corporate debt issuance taking place for this purpose. For instance, Microsoft issued $17 billion in a single go just a couple of days ago.

So, other than those wondrous stock buybacks, who gains from this debt-issuance activity? Well, that would be investment banks like Morgan Stanley (NYSE:MS) or Goldman Sachs (NYSE:GS), which take a commission for putting together and selling those massive quantities of debt.

Indeed, in Q4 2016 alone, Morgan Stanley had revenues of $4.6 billion in its Institutional Securities segment, out of which $1.5 billion (16.6% of Morgan Stanley's quarterly revenues) came from fixed income sales and trading, which will comprise these issuance activities.

So, here is where the insight comes in. What happens as soon as companies can repatriate their cash held abroad under favorable terms? Well, these companies will still conduct buybacks. In my view, they'll do about the same level of buybacks as before. But what they won't do is issue debt to finance them. Instead, they'll conduct these buybacks from cash on hand, which is cheaper than paying even a low coupon on high-quality corporate debt.

So what's the result here? Well, investment banks will lose a large source of fixed income commissions. So in short, debt repatriation is likely to be a net negative for investment banks, at least in what regards this particular business.

Conclusion

I haven't yet seen this cash repatriation insight written elsewhere. In my view, if cash repatriation goes forward, investment banks will see a hit to their fixed income revenues.

This also might lead to an odd sight: lobbying to not let cash repatriation conditions be too favorable.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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