Apple is Getting Paid to Raise Debt
Apple just raised $1.35 billion of Swiss-franc denominated debt in two tranches (0.28% and 0.74% implied yields), according to the WSJ. Apple is raising debt to fund its capital return program. In what can only be described as being at the right place at the right time, Apple is essentially getting paid to raise debt.
Apple may enter currency swaps to effectively convert Swiss Franc-denominated notes to U.S. dollar-denominated debt, which would increase the effective "cost" of the debt. Even taking this cost into consideration, Apple is in a position to earn a small profit by issuing debt. By raising debt, Apple is able to use borrowed cash to buy back AAPL shares, thereby saving on dividend expense. All else equal, and assuming an estimated $13 million after tax currency swap cost, Apple would make a profit of $1 million by raising $1 billion of debt at a 0.28% interest rate, as depicted in the table below.
Exhibit 1: How Apple Can Make a Profit by Raising Debt
Apple will have raised close to $40 billion after including today's debt issuance. It is important to recognize that the total amount of debt is spread out over various maturities ranging from 2 years to 30 years, depicted in Exhibit 2.
Exhibit 2: Apple's Long-Term Debt
By holding debt with a wide range of maturities, Apple isn't on the hook to repay the $40 billion at once. Instead, Apple will be able to use U.S. operating cash flow (or foreign cash in the event of U.S. corporate tax reform) to repay the debt as it comes due.
What is management's long-term strategy by raising debt?
- Use debt to fund share buyback for what management considers to be undervalued AAPL shares.
- Once AAPL shares are appropriately priced, slow the pace of buyback.
- With slower buyback, U.S. operating cash flow can be used to repay debt as it comes due.
- Repeat cycle with AAPL share valuation being the primary determining factor.
Management is utilizing proper capital allocation practices to not only take advantage of what they consider to be undervalued AAPL shares, but deal with excess cash weighing on Apple's cost of capital. Since $158 billion of foreign cash can not be used for share buyback or dividends, management is raising inexpensive debt as a substitute. Market observers look at this as a sign that management is confident in Apple's future and that the company won't likely require $100+ billion of cash for organic growth opportunities.
There will be a day when raising debt isn't in Apple's (and shareholders') best interest, but that day isn't today.
This report was produced by Neil Cybart on February 10, 2015 and is not meant to be used as investment advice. I publish a daily email about Apple called AAPL Orchard. Click here for more information and to subscribe.