Wednesday, May 1, 2013

Culture Threat: Apple Issues Debt

Culture Threat:  Apple Issues Debt

One of the most pristine balance sheets in the world is about to take on a slug of long-term debt.  For the past decade, Apple had no long-term debt at all. That is about to change.  The last time Apple issued debt was in 1996, when it raised a $300 million junk bond offering to invest in the business.  Today Apple will issue at least $17 billion in debt.  Clearly, the company doesn’t need the money to finance expansion or research and development.  Apple has $145 million in cash.  Equity investors have been clamoring for the company to return a good portion of the cash to them, and the debt deal is designed to do just that.
Standard Reports (1999)
At its recent annual meeting Apple announced a program to buy back $100 billion worth of stock in the next three years and increase the dividend by 15%.  Unfortunately, about $100 billion of the cash to pay for these initiatives is located overseas and would be taxed if it were repatriated.  Apple, of course, is extremely creditworthy, and Wall Street is more than willing to lend the company money to help finance these shareholder programs.

Does it make sense for Apple to borrow money instead of repatriating cash?   Undoubtedly.  Rather than incurring the corporate income tax as the cash comes back onshore, Apple will get to deduct the interest on the borrowed money.  As a result, it is more efficient for Apple to tap Wall Street and, at least for the moment, leave its foreign cash overseas.  However, this is not really the right question.

Instead, investors need to be asking whether this debt issuance marks the end of an era.  Has Apple’s future now become dependent on financial engineering rather than product innovation and growth?  Obviously, we will only know with the passage of time.  The phenomenal path that took Apple from a specialty player in the personal computer market into the mass retail market for music, mobile, and tablet devices may be coming to end.  However, it’s also possible that there’s another great innovation or two buried deep inside the company that will propel it forward.

I fear that this debt offering will prove addictive and undermine Apple’s culture and diminish the odds that the company will yet again awe consumers and investors.  Increasing earnings and maintaining a high return on shareholders equity is a daunting challenge when a company relies solely on innovation.  You have to keep developing products and services that are highly valued by consumers.  When debt enters the picture, it can, for a period of time, create the appearance of growth and high returns.  All too often, corporate managers find it is easier to boost per share earnings and RoE by borrowing from Wall Street.  As a result, debt can be habit forming and undermine the culture that spurs innovation and growth.

Apple’s culture and drive were Steve Jobs’ greatest gifts to the company and its customers.  For a time, it appeared that those gifts had survived his passing.   With this debt offering, his legacy may begin to whither as the tools of Wall Street become the key assets in Apple’s toolbox.  Don’t worry, consumers; debt addiction takes along time to erode a culture.  In the meantime, they’ll be a several more generations of IPhones and IPads.

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