Apple (Nasdaq: AAPL)
made history last month with the biggestcorporate bond issue
ever: $17 billion in six differentmaturities . That's more than
theGDP of the 29 smallest countries combined -- and Apple did it
by promising to pay just 1.4% ayear in interest.
Everyone caught the news, but many overlooked the huge
consequences it has for themarket . This deal has the potential
to push alot ofstocks higher and not just those tied to the
Cupertino, Calif.-based giant.
Applewill be using thedebt to return $100 billion to shareholders
through dividends andstock repurchases over the next two years.
Evidently, the Street likes the plan, with big investors like
David Einhorn buying moreshares and pushing the stock up more
than 15% since its low just before the announcement.
The best part? Apple will save $9.2 billion by using debt instead
of repatriating overseascash and $100 million a year from the tax
deductibility of interest expense.
But this isn't what has me so excited about the news. What has me
sobullish is the message this deal sends and how it shatters the
old myth of dangerous debt.
Times Change -- And Management Needs To Change With
I'm going to sound old, but not too long ago -- say, 30 years ago
-- the cost of debt was prohibitively expensive for many
The safestbonds around, the 10-yearTreasury note , hit a rate
close to 16% in the 1980s, and companies had to look toequity
financing for theircapital needs. After all, it doesn't make
sense to pay double-digit rates on bonds when you could pay
investors 10% or less to take anequity position in your company.
As rates continued to fall, the optimal funding mix of debt and
equity started to change. Companies could issue bonds cheaply,
write off some of the interest against theirtaxes , and not have
to dilute ownership by selling more shares.
But a holdover to the days of expensive bonds still remains, and
it's making some companies terribly inefficient. Many of the
old-timers on theboards of directors and in management still
consider it a source of pride that they can run a company with
nolong-term debt . They argue that the required interest payments
limit operational flexibility and that theircash flow more than
pays for capital needs.
But that's the old way of thinking.
After thetax benefit for interest, Apple will be paying an
average of 1.4% across the different maturities it issued. That's
less than the rate ofinflation , which has been running at 2.4%
over the past decade, and much less than thecost of equity
financing, which is between 4.7% and 8.5% for the general market.
Even companies with shaky fundamentals are able to issue less
than investment-grade debt, appropriately called junk bonds, at
rates around 5%.
Paying interest on aloan at less than the rate of inflation is
like getting freemoney .
An example: Say you take out a loan of $1 million with 2%
interest paid annually and theprincipal amount repaid after 10
years. You'll pay $200,000 in interest, but with 2.4% annual
inflation, the $1 million you repay in 10 years would only be
worth close to $784,329 today. You actually made $15,671 by
taking the loan.
Inflation is lower now, but it could grow much higher if the
world's central bankers keep the printing presses going. With
rates on investment-grade debt at or below long-term inflation,
it is irresponsible for management not to take advantage of
thefixed-income market. In addition to being able to pay back the
debt with money worth less than it's worth today, the company
also sees itsearnings improve through the tax-deductibility of
As the old school of thought becomes more accepted as the
dinosaur -- as it is by an increasing number of directors and
executives -- you are going to see more companies coming to the
debt market, increasing theirdividend and buying back stock.
Companies with no debt, stablesales growth and a positive return
on assets may soon take Apple's lead and issue debt to return
money to shareholders.
These Companies ArePrime Candidates To Borrow
Finding companies with strong sales growth and a positive return
on assets could help you get in front of the announcements and
pick up shares before the pop. These companies should have no
problem meeting the debt payments and will probably see higher
margins on that cheap money.
I've run a screen and looked through the financials of three
companies that could be strong candidates for this new debt
outlook. They should each be able to obtain an Arating from
Standard & Poor's, which S&P defines as "Strong capacity
to meet financial commitments, but somewhat susceptible to
adverse economic conditions and changes in circumstances."
Thecurrent yield for this rating is 2.88%, higher than Apple's
but still putting the after-tax rate of 2.16% below that of
Fastenal (Nasdaq: FAST)
is a $14.3 billion seller of industrial and construction
supplies. The company pays adividend yield of 1.6% and has $160
million in cash on itsbalance sheet . Sales have grown an average
of 9.5% over the past five years, including 13.5% last year on
the rebound in housing.
If Fastenal were to increase its debt-equity ratio from zero to
15%, well under the 48% average for industry peers, then it could
issue about $275 million in debt. That would be enough to buy
back 5.7 million shares or increase the dividend by 18 cents over
five years, which would boost the dividend yield to 2.1%.
Further, the company would see its earnings improve through the
$2 milliontax deduction on interest expense.
ARM Holdings (Nasdaq: ARMH)
is a $22.7 billion semiconductor company with a dividend yield of
0.5% and $882 million in cash on its balance sheet. Sales have
grown an average of 15.9% over the past five years and increased
17.4% last year.
IfARM were to increase its debt-equity ratio to 7.7%, in line
with the average for industry peers, then it could issue about
$165 million in debt. That would be enough to buy back 3.4
million shares or increase the dividend by 7 cents over five
years, which would raise the dividend yield to 0.6%. Further, the
company would see its earnings improve through the $1.2 million
tax deduction on interest expense.
Qualcomm (Nasdaq: QCOM)
is a $110 billion maker of digital communication products (and it
happens to count Apple among its customers). The company pays a
dividend yield of 2.2% and has $13.5 billion in cash on its
balance sheet. Sales have grown an average of 17.2% over the past
five years and jumped 27.8% last year on the surging smartphone
If Qualcomm were to increase its debt-equity ratio to 10%, just
under the 11.5% average for industry peers, it could issue about
$3.7 billion in debt. That would be enough to buy back 58 million
shares or increase the dividend by 43 cents over five years,
which would bump the dividend yield to 2.9%. Further, the company
would see its earnings improve through the $26.8 million tax
deduction on interest expense.
Risks to Consider:
For many companies, the current environment of low interest
rates and the benefits of issuing debt arefactors in just one
decision among a number of others to be made. The questions of
which companies will issue debt and how well their shares will
perform will be affected by many other decisions and the
broadereconomy . While the decision to issue debt and return cash
to shareholders should have a positive effect on the three
prospects named here, investors need to look at the whole picture
Action to Take -->
Companies with stable cash flows and a positive outlook would be
irresponsible not to tap historically low rates to lower
theircost of capital and return money to shareholders. More
companies are poised to follow Apple's lead and issue debt this
year, which shouldput more money in investors' pockets.
Note: Projections for debt issuance were determined by increasing
debt-equity ratio (long-term debt/stockholders' equity) to stated
goal. Issuance was then divided by stock price for share buyback
estimate or divided byshares outstanding for increase to
dividend. The increased dividend is divided by five years to
ensure sustainability. Thedebt-to-equity ratio across the market
is 32%. Typically, utilities finance more than half of the
company; by comparison, tech firms usually finance less than
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