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Apple Company’s Corporate Finance

Introduction

Apple Inc. is one of the technology companies that are doing so well. Apple Inc.’s market cap exceeds $500 billion, whereas, its cash balance is more than $100 billion. Although such information ought to bring joy to the stakeholders of the company, the release of the figures frenzied the company’s investors and stock analysts. Carl Icahn is one of the investors who feel that Apple should repurchase some of its shares instead of holding “too much” cash. Stock analysts have considered Icahn’s thoughts of repurchasing the shares but there are hitches. Firstly, it is noteworthy that most of the cash that Apple Inc. has is held in countries outside the US. Therefore, the company may face enormous tax penalties if it decides to repatriate the cash, and some investors are thinking of financing the payback through issuing a bond. This paper will take a stringent analysis of the worries that investors have about Apple holding “too much” cash. Thereafter, the paper will look at the two options of either financing the buyback using the excess cash or by issuing a bond. The discussions will give a clear outlay of the best option.

The investors’ worries

Investors have a reason to worry about the excess cash that Apple Inc. holds, and its lack of debts. Apple Inc. has “too much” cash balances to think of borrowing loans even if they are offered at low-interest rates. Essentially, a company without debts experiences a “low leverage” discount since tax laws favor companies with debts (Brown & Petersen 2011). The optimum debt ratios that Apple has ever recorded are between 40 and 50%. The company has a negative net debt ratio (-20%). The company’s cost of capital is approximately 9.5%, and if Apple Inc. had used debts, that amount would have been reduced to about 9% or less. The decrease in the cost of capital would increase the company’s value by more than $25 billion. Essentially, the investors have a reason to worry as Apple is forgoing some advantages of operating on debts in the contemporary world. Apple’s executives would find the 5% increment as negligible, but $25 billion is a significant amount of money.

Another reason for investors to worry is the fact that liquid cash earns a low rate of return (Fresard 2010). Apple has invested in low-risk investments such as commercial papers and treasury bills. The liquid investments earn Apple Inc. an income of less than 1% of the amount invested. This fact is so insinuating and the investors would feel like having their money back to invest in other worthwhile investments. From an investor’s point of view, it would be worthwhile to invest in high-risk investments that would earn more income than the 1% that Apple Inc. earns from its low-risk investments (Chan et al. 2010).

From the literal view of things, Apple Inc. is doing well as its market cap and the cash balance is somewhat encouraging. However, the price/earnings ratio (P/E ratio) raises the eyebrows of the investors. Over the past few years, Apple’s stock prices have had a run-up, but the company still maintains its earnings per share at the same level. The average market price/earnings ratio ought to be about 25 times the amount earned per share (Fazzari, Hubbard & Petersen 2000). For Apple Inc. that is doing considerably well in the market, the amount should even be higher. However, the truth is that Apple’s P/E trailing earnings are 16 times the earnings per share. The company’s forward earnings are estimated to be about 13 times the earnings per share. Considering Apple’s position, the figures are somewhat low, and they reflect a naiveté discount. Investors would keep on wondering how low the earnings per share would go if Apple Inc.’s stock prices dropped by 50%. Indeed, it would mean that the shareholders would receive no dividends; therefore, investors have a reason to worry.

As it applies to any individual, liquid cash is very tempting to spend. Apple Inc.’s executives handle so much liquid cash, and they might be tempted to misuse the cash. The executives would be enticed to invest in bad investments that have risks that surpass the returns on investment. At the end of the day, the hard-earned income would be discounted. Essentially, the same managers who have always managed the company to its success may have some confusion given the enormous amounts of cash balances. Indeed, Apple Inc. has more cash than needed to maintain the errands of the company. If it cannot find productive uses of the cash that it holds, it would rather use the cash to repurchase the shares. The technological market overturned things on high-flying companies like Microsoft and Intel in the recent past. Probably, Apple Inc. could take a misstep with the enormous amounts of cash that it holds, and it would experience a big blow. With this in mind, the investors have a reason to worry, and indeed, Apple should buy back some of its shares.

Financing the share repurchase

If Apple Inc. decides to buy back its shares, two things are involved; Apple will either fund the buyback using its excess cash or through the proceeds of a bond issue. Indeed, either of the options will have some risks that would affect the company.

Non-operational cash (excess cash) is very important in guiding the company against unanticipated cash flow shocks in the future (Baum, Stephan & Talavera 2009). Therefore, if Apple Inc. uses its excess cash to fund the payback, the company would be risking its operations in the unpredictable technological industry. From one time to another, the cost of external capital may rise considerably. If Apple Inc. uses its excess cash to finance the buyback, it would have difficulties in funding its capital expenditures. The company may be forced to seek funds from external credit institutions at high-interest rates. The company will have to undergo the transaction costs and experience many inconveniences concerning their incredibility to borrow huge amounts of money. If, for example, the managers have some information asymmetry about equity, the capital markets may consider the company as ineligible to access funds. To avoid such inconveniences, Apple Inc. would rather not exhaust its non-operational cash on funding the repurchase of some of its shares (Foley et al. 2007).

Excess cash offers the company the opportunity to obtain anything unconditionally, therefore, lack of cash will be risky whenever the company obtains a lucrative deal. Corporate liquidity enables the company to have financial flexibility that is highly valued; with liquid cash, all the uncertainty issues are solvable (Bates, Kahle & Stulz 2009). As stated earlier, the excess cash that Apple Inc. is said to have is held outside the US, and the company would face enormous tax penalties in trying to repatriate the money. Therefore, the company may end up salvaging very little money that may not meet their needs.

The option of funding the repurchase through the proceeds of a bond issue is somewhat favorable. Other than enabling the firm to have access to funds that ought to be paid back after a long period, the credit line option would enable Apple Inc. to explore the business opportunities available in good economic times to come (Lins, Servaes & Tufano 2010). Apple may be self-sufficient given the enormous profits that it generates from its activities, but issuing a bond to generate cash would be recommendable. It is noteworthy that no company can become tired of expanding its operations to earn more profits than before. Indeed, the money obtained from the issue of a bond would provide the company with funds to exploit international markets.

Unlike the credit markets that offer their loans at considerably high-interest rates, a bond would offer Apple Inc. an opportunity to negotiate the interest rates (Lee & Suh 2011). The company will access external funds to finance the payback without any hassles. Moreover, the issue of a bond will bring yet another factor to consider in the management role. The payment of the coupons of the bondholders will bring in some diplomacy in the managerial role. Depending on the agreed terms and conditions and the maturity periods of the bond, the managers will have to be more careful about the financial activities of the company.

One of the worries of the investors was the “low leverage” discount for Apple Inc. since it has no debts. It is noteworthy that issuing of bonds has some tax advantages associated. Apple Inc. will benefit because the interest paid to bondholders becomes a deductible expense on the federal income tax return. By issuing a bond to buy back some of the shares; the company will reduce the cost of paying dividends that are allotments of part of the profits (Grullon & Michaely 2004). The company will save some substantial amounts of money since the income tax savings will reduce the cost of borrowed funds. Essentially, the amount of income tax savings will depend on the income tax rate of the bond issuer; therefore, Apple Inc. will have a great chance to equilibrate the amount of taxes that it pays to the government.

Conclusion

From the discussions, it is evident that Apple Inc. would experience many benefits if it funds the repurchase of some of its shares through a bond issue. The company will have the liquid cash to run its errands, and at the same time, it will have satisfied the needs of its shareholders. The unconditional liquidity of cash will be available in good and in tough economic times to help Apple Inc.’s executives to run the activities of the company without much difficulty. With a cash balance of more than $100 billion, it is evident that Apple Inc. would not need to borrow funds from capital markets. The worry of mismanagement of excess funds will be eliminated, as the executives will be struggling to ensure that they pay coupons to the bondholders. The fact that the company’s executives may hoard the excess cash for their private use is not ignorable, but it is not a sufficient reason to eliminate liquid cash. Therefore, if I were a shareholder, I would prefer Apple Inc. to fund the share repurchasing exercise through the proceeds of a bond issue.

References

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Baum, CF, Stephan, A & Talavera, O 2009, ‘The effects of uncertainty on the leverage of non-financial firms’, Economic Inquiry, vol. 47, no. 2, pp. 216-225.

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Fazzari, SM, Hubbard, RG & Petersen, BC 2000, ‘Investment-cash flow sensitivities are useful: A comment on Kaplan and Zingales’, Quarterly Journal of Economics, vol. 115, no. 2, pp. 695-705.

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Fresard, L 2010, ‘Financial strength and product market behavior: The real effect of corporate cash holdings’, Journal of Finance, vol. 65, no. 1, pp. 1097-1122.

Grullon, G & Michaely, R 2004, ‘The information content of share repurchase programs’, Journal of Finance, vol. 59, no. 1, pp. 651-680.

Lee, BS, & Suh, J 2011, ‘Cash holdings and share repurchases: International evidence’, Journal of Corporate Finance, vol. 17, no. 1, pp. 1306-1329.

Lins, KV, Servaes, H & Tufano, P 2010, ‘What drives corporate liquidity? An international survey of cash holdings and lines of credit’, Journal of Financial Economics, vol. 98, no. 1, pp. 160-176.