Apple CEO Tim Cook has had a rapidly growing problem. Truth be told, he’s had more than one: a stock price that has plummeted 40 percent from its peak last fall, slowing revenue growth and declining margins, Samsung’s leapfrogging ahead in the smartphone race, the need to respond by delivering a new hit product and, now, wholly unsubstantiated whispers that his job might be in trouble.
So the list was long, but near the top, at least from shareholders’ perspective, was Apple’s tremendous cash hoard – once it passes $100 billion it absolutely has to be called a hoard, right? – which now totals $144.7 billion, a nearly 6 percent increase from $137.1 billion last quarter. Grumbling shareholders, eager for a strategy to stem the stock slide, have been pressing and pleading for Apple to do something useful with its cash, or give much of it back in the form of dividends and stock buybacks.
Tuesday, Cook responded, unveiling plans to use lots more cash in the hopes of winning back investor affection. Apple announced Tuesday that it will hike its dividend by 15 percent and will spend $55 billion more on buying back shares, returning $100 billion in total to shareholders by the end of 2015. Here’s the twist, also announced Tuesday: Apple will borrow the money that it will be paying out to shareholders.
For all its perceived problems, Apple clearly doesn’t have an issue generating cash. “We continue to generate cash in excess of our needs to operate the business, invest in our future, and maintain flexibility to take advantage of strategic opportunities,” CFO Peter Oppenheimer said in a release announcing the plans for the cash. So why on earth is the company going to tap the credit markets and borrow billions when it already has $145 billion available?
The answer is simple: to avoid paying taxes. “We are continuing to generate significant cash offshore and repatriating this cash would result in significant tax consequences under current U.S. tax law,” Oppenheimer said on a Tuesday afternoon call with analysts. Issuing debt now will bring other financial benefits as well, Oppenheimer explained on the call. By paying low interest rates on its debt and being able to deduct that interest from its U.S. tax bill, Apple will reduce its overall cost of capital.
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Apple now has $102.3 billion overseas, up from $82.6 billion as of the end of September. As of September, the end of its fiscal 2012, Apple had $40.4 billion “permanently reinvested” overseas, according to an SEC filing. The company estimated it would owe $13.8 billion in taxes on those holdings if it returned them to the U.S. That works out to a 34 percent tax rate, suggesting that Apple had been paying very little in taxes to foreign governments.
Analysts had increasingly been suggesting that Apple should take on debt to finance its shareholder payouts. “[T]he prospect of Apple leveraging up for a bigger stock buyback and dividend program could build a ‘New Apple’ focused on monetization of innovation and also greater shareholder returns,” J.P. Morgan analyst Mark Moskowitz wrote last week. Moskowitz, who had set a $725 price target on the stock, noted that nearly 70 percent of Apple’s cash is held overseas. “Given the company’s strong operating profit and cash flow metrics, we would expect Apple’s borrowing rate to be 2.5 percent to 3.0 percent, which is much better than paying 25-30 percent tax on cash repatriation.”
The financial maneuvers could make Apple “Exhibit A” in the contentious debate over the need to reform the corporate tax code by reducing the statutory rate from its current 35 percent while closing loopholes. Those loopholes and deductions have brought the effective federal rate paid by companies to a 40-year low of about 12 percent. Apple paid a 26 percent effective tax rate for the three and six-month periods through the end of March.
“We have a huge problem with our international tax system,” says Rebecca Wilkins, senior counsel for federal tax policy at the left-leaning, non-profit Citizens for Tax Justice. “The fact that corporations are allowed to defer paying the money until they bring the money home causes all kinds of economic distortions and a whole lot of game-playing.” Apple’s filings make clear that it is taking advantage of global tax differences, a common corporate practice. “They’re not selling a lot of iPads in some of these tax haven countries where the median income is a few hundred dollars a year, but they’re playing accounting games to book the profits there,” Wilkins says.
Citizens for Tax Justice advocates ending the tax deferrals and having companies pay taxes on profits when they are booked, wherever they are booked. “That eliminates the incentive for game-playing,” Wilkins says. Business groups, meanwhile, have been pushing to lower the tax rate and, in some cases, for a territorial tax system that would not subject companies’ foreign profits to U.S. taxes.
In comments submitted this month to the House Ways and Means Committee’s International Tax Reform Working Group, a coalition of companies (not including Apple) wrote that the current “worldwide” tax system “represents the worst aspects of our tax code – it is overly complex and often forces U.S. companies to make business decisions based on tax law, instead of responding to the demands of customers.”
As Apple demonstrated yesterday, until the corporate tax system is fixed, the games will go on.
