How Apple Inc. Is Increasing Shareholder Value Through Debt

• Apple reported nearly $235B in cash and cash equivalents, as of the latest quarter.
• However, the company is still raising debt with every passing quarter.
• The strategy to raise debt could, in itself, create billions of dollars worth of shareholder value.

Apple, Inc. (NSDQ:AAPL) reported a cash balance of $235B in the latest quarter, with over $214.8B sitting in overseas tax havens. Inspite of the huge cashpile, the company has consistently accessed the debt markets to fund its huge capital returns program. This raises the question as to why is the company not using its cash hoard to finance its dividend payout and share repurchase programs.

The obvious answer to the above question is that the majority of its cash is stashed in overseas tax havens, repatriation of which would cost the company a huge tax bill. A follow-up question is, why is Apple even raising debt, given the associated interest costs which accompany the debt? A couple of reasons. One, there is increasing amounts of pressure on the company to return capital to shareholders. Also, by resorting to debt, Apple could, in fact, be saving billions of dollars by borrowing at really low-interest rates and using these borrowed funds to reduce its share count. Let’s see why.

Apple is able to raise the cash at unbelievably low rates.

Apple has been consistently borrowing over the last couple of years and using the same to reduce its float (number of shares) through share repurchases. Based on the company’s outstanding debt at the end of Q3 (June 2016), Apple’s effective after-tax borrowing rate came in at an unbelievably low 1.84% (See table below).

	Maturities	Amount ($, in millions)	Interest range	Effective Interest Rate	Effective interest ($, in millions)
2013 debt issuance of $17.0 billion
Floating-rate notes	2018	$2,000		1.10%	22
Fixed-rate 1.00% – 3.85% notes	2018-2043	12,500	1.08% – 3.91%	2.50%	311.88
2014 debt issuance of $12.0 billion
Floating-rate notes	2017-2019	2,000	0.70% – 0.93%	0.82%	16.3
Fixed-rate 1.05% – 4.45% notes	2017-2044	10,000	0.70% – 4.48%	2.59%	259
2015 debt issuances of $27.3 billion
Floating-rate notes	2017-2020	1,774	0.68% – 1.87%	1.28%	22.62
Fixed-rate 0.35% – 4.375% notes	2017-2045	25,347	0.28% – 4.51%	2.40%	607.06
Second quarter 2016 debt issuance of $15.5 billion:
Floating-rate notes	2019	500		1.47%	7.35
Floating-rate notes	2021	500		1.78%	8.9
Fixed-rate 1.30% notes	2018	500		1.32%	6.6
Fixed-rate 1.70% notes	2019	1,000		1.71%	17.1
Fixed-rate 2.25% notes	2021	3,000		1.80%	54
Fixed-rate 2.85% notes	2023	1,500		2.50%	37.5
Fixed-rate 3.25% notes	2026	3,250		2.40%	78
Fixed-rate 4.50% notes	2036	1,250		4.54%	56.75
Fixed-rate 4.65% notes	2046	4,000		4.58%	183.2
Third quarter 2016 Australian dollar-denominated debt issuance of A$1.4 billion:
Fixed-rate 2.65% notes	2020	487		1.92%	9.35
Fixed-rate 3.35% notes	2024	337		2.61%	8.8
Fixed-rate 3.60% notes	2026	243		2.84%	6.9
Third quarter 2016 debt issuance of $1.4 billion:
Fixed-rate 4.15% notes	2046	1,377		4.15%	57.15
Total term debt		71,565			1770.45
				Effective interest rate	2.47%
				After tax cost of debt	1.84%

Source: Apple SEC filings

The company is utilising the borrowed funds to finance its stock buyback program and pay its dividends. Quoting Luca Maestri, CFO, Apple from the Q2 2016 earnings call:

We expect to fund our capital return program with U.S. cash, future U.S. cash flow generation, and borrowing from both domestic and international debt markets.

Apple Stock Is Trading AT All-Time Low Valuations

Apple stock is currently trading below its historical valuation levels. The stock is currently trading at a PE ratio of 12.78, which is significantly below its average 5-year and 3-year PE multiples of 13.7 and 13.91, respectively. Also, the company is trading at an ex-cash PE multiple of lesser than 10. These are valuations which are highly attractive in the technology space.

Source: Apple PE ratio chart by uniquefinance.org

Executing accelerated share repurchase programs at these low levels allows Apple to retire a greater number of shares using the same amount of funding.

Apple pays a higher dividend on its outstanding shares.

Apple currently has an annualized dividend yield of 2.1%. Given the generally stable dividend policies corporations follow, it would be fair to assume that the explicit cost of equity (annual cash outflow w.r.t common stock) for Apple would be 2.1%, at least. The implicit cost of equity would be much higher which can be got using the more sophisticated CAPM model. Apple, Inc.’s cost of equity is estimated to be around 12%.

However, by just taking into consideration the annual cash outflow (in the form of dividends) to common stockholders, it would be fair to assume that common stock will cost Apple, Inc. over 2% annually, which is significantly higher than Apple’s cost of Debt.

Repatriation could cost 35% which will be a significant hit.

While repatriating its cash and using the same to finance its capital return program would be the best move in a scenario of no taxes, given the 35% repatriation tax the firm could be exposed to, the move to borrow funds is effectively a very smart move by the Apple management.

Conclusion

In conclusion, Apple is effectively reducing its overall cost of capital and increasing shareholder wealth by borrowing at interest rates which are lower than its dividend costs. Apple Inc. should continue to borrow as long as the company can keep its effective borrowing rate below its dividend yield and use the borrowings to reduce its outstanding share count. The move leads to maximization of shareholder wealth over the long term in the form of higher earnings per share and lower overall cost of capital.

Hence, borrowing while lobbying for a repatriation tax break is a smart move by Apple Inc.