Why would a company with almost $145 billion in cash, cash equivalents, and marketable securities borrow $17 billion to buy back shares? Apple announced in April it would borrow those billions to fund share repurchases of up to $60 billion by the end of 2015. Apple also announced it was raising its third quarter 2013 cash dividend by 15 percent to $3.05.
As of March 30, 2013, $102.3 billion of Apple’s cash, cash equivalents, and marketable securities were assigned to foreign subsidiaries but, generally, held in US dollar-denominated assets. Bringing that cash “back home” to fund the share buybacks would have cost Apple at least $9.2 billion in taxes at the 35 percent corporate tax rate, according to a Moody’s analyst quoted in The Financial Times. As Chicago Booth Professor Steven Kaplan noted in a recent story on American Public Media’s Marketplace show, because of the tax code, it’s often cheaper to borrow cash than to repatriate it.
A Senate report on Apple’s tax avoidance, however, says the “offshore” cash is actually managed in Reno, Nevada, accounted for by Apple company bookkeepers in Austin, and held in bank accounts in New York. The United States tax code considers the money to be under foreign control because it’s assigned, on paper, to two Irish subsidiaries.
Apple is not the only one that would rather borrow to fund this return of capital to shareholders. Costco borrowed $3 billion late last year to fund a special dividend. Intel, DirecTV, and Best Buy took on debt to fund share repurchases. Microsoft, Hewlett-Packard, Google, and Abbott Labs have also been scrutinized in the US and UK for alleged tax avoidance schemes that shift global cash and profits to low or no tax jurisdictions.
In a recent paper, Chicago Booth Professor Douglas Skinner, and PhD students Eric Floyd and Nan Li, discuss the growth of share repurchases and the resilience of dividends during and after the financial crisis. It used to be that share repurchases signaled management’s view that shares were undervalued. You would expect share repurchases to be more frequent when stock prices are low, but that’s not been the case. Repurchases, the researchers say, are now mostly pro-cyclical and occur even when stock prices are at relative highs, such is the case at Apple.
As the financial crisis began, industrial companies reduced dividends modestly but cut repurchases aggressively. Industrial companies cut repurchases from $448 billion in 2007 to $309 billion in 2008 and then to $128 billion in 2009 (by 70 percent overall). Aggregate repurchases rebounded to $213 billion in 2010, close to the same level as aggregate dividends ($214 billion), and then to $331 billion in 2011, well in excess of dividends, according to the researchers.
Industrials, especially high dividend payers, use repurchases to supplement dividends. Overall payouts (relative to earnings) have now increased to levels that are very high by historical standards. In 2007 industrials, as a group, paid out 90 percent of aggregate earnings. Skinner and colleagues ask the question: If US firms are collectively distributing close to 100 percent of earnings, is aggregate investment too low? Does ongoing economic uncertainty, even five years after Lehman’s failure, explain the lack of investment?
Uncertainty, according to the researchers, should lead to higher cash holdings rather than cash payouts–and, to some extent, it has. A recent report in Treasury and Risk Magazine says companies were holding $1.79 trillion at the end of last year. But they’re not investing that cash in the new products or services or workers. Instead, Standard & Poor’s says companies bought back $99.15 billion of their stock during the fourth quarter and paid shareholders $79.83 billion in dividends. Banks, in particular, have been anxious to reinstitute payouts after the crisis at the expense of building a capital cushion.
Why, then, is Apple planning to return $60 billion in cash to shareholders by the end 2015? It’s the largest single share repurchase authorization in history and Apple is already among the largest dividend payers in the world, with annual payments of about $11 billion.
In a press release about the program, Tim Cook, Apple’s CEO, said, “We so believe that repurchasing our shares represents an attractive use of our capital that we have dedicated the vast majority of the increase in our capital return program to share repurchases.”
Apple doesn’t need to use dividends to signal financial strength or repurchases to prop up an undervalued stock price. Instead, the company’s strategy of high dividends and huge share repurchases is consistent with the response of large, mature firms in low-growth industries to the “agency cost of free cash flow” problem. When executives may be tempted to use large, free, consistently-generated cash flows to finance initiatives that will earn low returns, it’s better to return the cash to investors. That way you can't be accused of wasting it on a vanity project.
If you want to read the paper, “Payout Policy Through the Financial Crisis: The Growth of Repurchases and the Resilience of Dividends,” find it here.