The world was watching Apple’s quarterly results disclosure on Monday after the US markets close. CNBC even managed to have nine pundits simultaneously lined up to give ‘insight’ (which they of course collectively failed to do so!)
The most striking number from the Apple numbers was not how many iPhones were sold or how the company is getting on in China but cold hard cash. Did you see just how much cash they hold on their balance sheet? A mere US$158bn! That’s a third of their market capitalisation and equivalent to about 90% of the current market capitalisation of Vodafone, one of the largest companies in the UK market. Whatever way you look at it, that’s a serious sum of money.
If you pick up a book on corporate finance you will find something called the ‘Modigliani-Miller Theorem’ which basically says that it is optimal for a company to hold debt so long as they have a good and steady income stream. Investment bankers took this academic theory to its logical extreme, brokering deals that made sense on paper…but ended up in a debt-heavy mess when either interest rates went up (the late 1980s) or the income stream stopped flowing (2007-9). It’s the sort of thing investment bankers do – bonuses and all that!
As companies are generally accountable to their shareholders and have to pay their way, the current prudence of the average corporate balance sheet – compared to the average government or even household balance sheet – stands out. Whilst Apple may have the biggest cash pile, it is by no means alone: big rivals of the company like Google or Microsoft are in exactly the same situation. Large non-financial companies around the world share one major concern: that governments and individuals are, on average, living beyond their means. The continued extensive use of unorthodox policies like QE reflects the difficulty of generating reasonable and sustainable levels of economic growth with this particular calibre of backdrop. So if you are a corporate CEO/CFO you keep cash back and don’t buy as many shares back as your activist investor base are lobbying for (sorry Mr Icahn!), just in case it gets economically nasty out there again… Sure, there have been some big M&A deals struck in recent months but after five years of an effective developed world ZIRP (zero interest rate policy), where money can be borrowed more cheaply than at any point in 50 years and any deal will almost immediately be earnings accretive (thanks Modigliani-Miller), the amount of deals has been lacklustre at best. We still await the merger frenzy.
The other reason is nothing to do with geopolitics, the rise of Chinese competition or lack of business ideas. It is to do with that arcane but important subject of tax planning. Take Apple’s cash pile as an example. Three-quarters of it is held overseas, having been accrued via the company’s cumulative global ex-US business profits over time. So why not bring it back to the US? Well, if the company did this they would be stung by a material tax bill of good Ol Uncle Sam!
And so the lobbying starts. Even a temporary reduction in repatriation taxes could raise a healthy sum for the hard-pressed US government coffers. These monies could be used for buy backs, investment, dividends or acquisitions and everybody – at least in America – would appear to be a winner. I am almost surprised it was not in Barrack Obama’s State of the Union Address on Tuesday.
So, Apple and other Silicon Valley giants retain large cash holdings due to the fear of the underlying reality of many economies and tax planning. Very modern financial bedfellows…
By Chris Bailey of FinancialOrbit