When it was becoming apparent that tax reform was going to become reality, I penned this piece criticizing the market’s rotation out of the technology sector and into other areas of the market with higher concentrations of domestic exposure resulting in higher effective tax rates. I thought this was a short-sighted trade which ignored the strong secular tailwinds that have made many of the high growth tech names relative out-performers. I also thought this rotation was ignoring one of, if not the most important aspect of the tax reform bill: repatriation. Sure, many of the leaders from Silicon Valley won’t experience a massive tax break because of the recently passed tax bill, but they will have much cheaper access to their gargantuan overseas cash hoards.
When looking at the balance sheet of the Silicon Valley habitants, we see that there are no shortages of companies with tens of billions of cash on hand. This recent list put together by Business Insider says it all:
As you can see, the top five companies in the U.S. as far as cash reserves go are technology names. Oracle, Cisco, Alphabet, Microsoft, and Apple are the only U.S. companies with more than $50b stashed away. Alphabet is nearing the $100b threshold and Microsoft has achieved it, with its $133b on the books. But it’s Apple absolutely blowing away the competition with its reserves surpassing $260b (with the vast majority of those funds being currently held overseas).
Just think about that for a second…$260b. That’s more money than many of the world’s developed nations have in reserve. People oftentimes express a desire that Apple moves into the original content space, right? Well, that’s so much money that Apple could buy Walt Disney (DIS) and Netflix (NFLX) and still have ~$40b cash left, meaning it would still be 6th place on Business Insider’s list.
Okay, okay, I know those theoretical situations are fantastical. I also understand that the tax implications of repatriation and M&A premiums would significantly change he calculous of theoretical scenarios like this. Regardless, it’s fun to think about what you’d do with that $260b if you were Tim Cook and I’m just trying to drive home the truly impressive nature of Apple’s unprecedented cash reserves.
I’m personally long every company in the top five of this list except for Oracle (and 14 out of the top 17 names). Cash on hand is typically a result of many of the profitability metrics that I track during my due diligence process. Cash reserves also play a direct role in my stock selection process; I sleep better at night knowing that the companies I hold have very large cash positions.
Why? Because it gives companies flexibility. Cash can be used in a variety of fashions to widen a company’s moat and sure up a business against potentially disruptive competition. Cash can be used to buy growth. Cash can be used to attract better talent. And, most notably to an income oriented investor, cash can be used to return to shareholders, in either the form of a dividend or share buybacks.
Now that tax reform has passed we’re beginning to see companies roll out plans for repatriation. Apple hasn’t made any specific statements regarding its plans for its overseas cash, but yesterday I saw a report published by CNBC highlighting UBS reiterating its “buy” rating on Apple, in large part because of AAPL’s ability to use repat riated funds to increase its buyback. The UBS analyst believes that Apple could buy back “$122 billion worth of its shares through 2019.”
I read this headline and though, “Great, more buybacks.”
However, after reading internet commentary on the news, it appears that I’m in the minority with my approval. It always amazed me when I see such vitriol from investors on news of large scale share count reductions like this. Oftentimes I see individuals clamoring for increased dividends or even a special dividend in a special situation like this repatriation scenario. I know people harken back to Microsoft’s (MSFT) big special dividend after President Bush’s one-time repatriation back in 2004 when they look at Apple’s current situation, but it’s very difficult for me to justify such a capital allocation decision.
First of all, I don’t like to pay taxes. As a dividend growth investor, annual dividend taxes are a part of my life that I’ve come to accept, but I don’t necessarily want to see massive increases here. If Apple were to pay a large special dividend, there would be large tax implications for shareholders. This tax would cut into the total cash received, making it a somewhat inefficient way to reward them.
My view is that the market’s fascination with special dividends is driven by short-term greed. Don’t get my wrong, I love extra cash in my pocket, but not at the expense of long-term dividend growth. Investors that are an uproar against the hundred-billion-dollar buyback that UBS brought up are ignoring the fact that not only does a buyback increase the value of their holdings via the simple rules of supply and demand, but it also makes long-term dividend growth more sustainable for Apple moving forward.
Sustainable dividends are paid with free cash flows. Apple will not reduce its ability to produce profits by spending its cash reserves on share buybacks. With every share that is retired, the earnings per share on the remaining in the float will incrementally rise. This means that Apple’s dividend payout ratio will fall as shares are bought back, making it easier to management to justify future increases.
Apple currently yields ~1.5%. Apple’s last four quarterly dividend payments amounted to $2.46/share. Since initiating its dividend in 2012, AAPL has rewarded shareholders with annual dividend increases in the 10% range. I expect this trend to continue for the foreseeable future. Assuming that the quarterly dividend is increased to ~$0.70/share in May, investors should receive roughly $2.70/share in 2018. This means that every share retired by the company will save it ~$2.70. This might not sound like much, until you realize just how many shares will likely be retired.
This cash savings isn’t a one time benefit of a buyback for the company either. I, for one, expect to see Apple evolve into a dividend aristocrat. This means that every share retired in the present not only saves the company one annual dividend payment, but years and years worth of payments (growing at ~10%/share). Dividend growth investors pay a lot of attention to the compounding nature of their income stream…well, Apple management is likely paying a lot of attention to the potential compounding of the savings it enacts by retiring these dividend paying shares.
I was also taken aback by much of the backlash I read from those who claim to be Apple shareholders because management making buybacks a priority should not have come as a surprise. Apple has already spent record amounts of money buying back its own shares under Tim Cook. What’s more, these buybacks have proven to be quite effective (with Apple hovering at all-time highs, it’s safe to say that just about all of the retired shares were purchased at discounts to the current share price). Management has long believed that AAPL shares were undervalued and it appears that thus far, they’ve been correct.
Apple has been buying back ~1% of its shares on a quarterly basis for years now and I think this is a great use of the company’s excess cash. Apple’s stock is more expensive now than it has been in years, but it’s still trading well below the broader market’s multiple. Apple has been plagued with what I believe to be an irrationally low premium as investors focus all of their energies on the company’s reliance on hardware (especially the iPhone) and ignore things like a quickly growing services segment as well as the aforementioned enormous balance sheet. Apple is my largest holding because I believe these shares to be undervalued and I cannot fault AAPL management for using its excess cash to buyback shares when there aren’t better values available out there in the marketplace.
I see some shareholders wishing that Apple would use its money to buy growth and diversify its product portfolio; however, I don’t expect Cook and Co. to head down this path either. Apple has been cash rich for some time now and it has never made a large acquisition. The company spends large sums of money on its own R&D and apparently doesn’t see the need to pay high M&A premiums elsewhere in the market. I’m fine with this as well. Sure, it’s exciting to hear rumors of Apple buying flashy companies like Netflix or Tesla (TSLA), but as an Apple shareholder, I would much rather them stay the current course. I wouldn’t be surprised to see the company use its overseas cash for several small strategic acquisitions, but I’m not going to hold my breath waiting for the sometimes rumored Apple/Walt Disney merger.
And lastly, I see some shareholders complaining that the UBS report doesn’t make mention of paying down debt. Apple has increased the leverage on its balance sheet significantly in recent years, using a lot of that money to pay dividends and buybacks. On the surface, this seems like an unsustainable practice and generally, I’m opposed to companies raising debt for shareholder returns, but Apple’s cash is different. This company is able to get ridiculously low rates. When it first started raising debt its dividend yield was much higher than it is today and the company was actually saving money with its leverage. After the recent share price run-up, I don’t think this is the case anymore, but I’m still fairly sure that AAPL is getting much higher rate of returns with buybacks than the interest that it’s paying on its debt.
So, at the end of the day, when it comes to investors who’re somehow upset about the fact that one of their companies is bringing home ~$250b with the likelihood returning the majority of those funds to shareholders, I’m going to take a page from Aaron Rodgers book and say, "R-E-L-A-X...relax."
Apple current management team has done a wonderful job of generating wealth for its shareholders. I know people like to criticize this company’s lack of diversification and/or growth, but this is simply noise. Just look at the total returns that AAPL has provided shareholders and you see that the proof is in the pudding. I wholeheartedly expect to see continued massive buybacks with repatriated cash and this doesn’t upset me in the least. I’m actually quite happy about it and I think you should be too.
disclosure: I am long AAPL, CSCO, GOOGL, MSFT, DIS