The holiday season was particularly kind to Microsoft (NASDAQ:MSFT) and Apple (NASDAQ:AAPL). After years of watching billion-dollar cash piles accumulate overseas, with management unable to use the money to directly enrich shareholders, on Dec. 22, 2017, President Donald Trump signed into law the Tax Cut and Jobs Act of 2017. Included in this overhaul of the tax code was a provision specifically friendly to these two tech giants, as it enacts a maximum tax of 15.5% on earnings held abroad.
Apple responded by unveiling plans to bring home nearly all its foreign cash, noting it would pay approximately $38 billion in taxes, which would cover the repatriation tax on $245 billion alongside plans to hire 20,000 people (more on that later). However, Microsoft has been less forthcoming on disclosing plans for its foreign cash hoard, which totaled $132.1 billion as of its last earnings announcement.
The cash is foreign in name only
Before we discuss Microsoft's plans, it's important to understand why we're even having this discussion. Under the old tax system, American companies were taxed on foreign profits, but the taxes were not due until the money came back to the United States, aka repatriated. A tax rate of 35% provided a disincentive to repatriate the money. Many companies, Apple and Microsoft included, would open foreign subsidiaries in low-tax countries and attribute profit to those operations. The end result was the aggressive growth of foreign cash.
Many investors think of foreign cash as the money being physically tucked away in a vault in Ireland or some other low-tax locale. But that isn't correct. While the money remains in an account attributable to a foreign subsidiary, the cash is generally in dollar-denominated investments to avoid foreign-currency losses. From Microsoft's quarterly report [emphasis mine]:
Of the cash, cash equivalents, and short-term investments as of September 30, 2017, $132.1 billion was held by our foreign subsidiaries and would be subject to material repatriation tax effects. The amount of cash, cash equivalents, and short-term investments held by foreign subsidiaries subject to other restrictions on the free flow of funds (primarily currency and other local regulatory) was $2.4 billion. As of September 30, 2017, approximately 88% of the cash equivalents and short-term investments held by our foreign subsidiaries were invested in U.S. government and agency securities, approximately 3% were invested in U.S. mortgage- and asset-backed securities, and approximately 2% were invested in corporate notes and bonds of U.S. companies, all of which are denominated in U.S. dollars. The remaining cash equivalents and short-term investments held by our foreign subsidiaries were primarily invested in foreign securities.
Before "repatriation," Apple was a little more aggressive with its cash pile, with approximately 57% of total cash in corporate securities.
The foreign-held money hasn't been doing nothing
While holding the cash overseas doesn't affect Microsoft's security selection, it does prevent the company from using the money to enrich shareholders with dividends and share buybacks, at least directly. Indirectly, however, Microsoft's foreign cash has been enriching shareholders for years.
Since 2012, the company has returned $121 billion in cash to shareholders in a combination of share buybacks and dividends. The company can afford to do so as it generated $170.4 billion in free cash flow (cash from operations minus capital expenditures) during this period. However, much of this was through foreign operations, as foreign-held cash grew approximately $78 billion in this time frame, from $54 billion to $132.1 billion.
What Microsoft and Apple have done is to take out debt to return cash to shareholders. As the chart below shows, Microsoft's increase in total debt during this period is similar to the company's growth in foreign-owned cash.
Certainly Microsoft could pay a special dividend or increase its buyback program with repatriated money, but the company has already essentially spent a lot of its foreign-held cash by taking on debt to do just that. Therefore, it's possible stakeholders that will benefit the most from repatriation directly are Microsoft's debtholders.
Earlier this year, ratings firm Moody's warned Microsoft it could lose the coveted AAA credit rating after the company went to the debt markets to partially fund the LinkedIn purchase. Bringing this money home means the company will have no doubts of its ability to pay the collective $28 billion in debt due in the next five years and debt should trade higher...or at least be less at risk of a downgrade.
Don't buy the jobs hype
Although the Tax Cut and Jobs Act was prefaced as a way to increase jobs, don't look for a huge boost in nationwide employment from this particular provision. Both Apple and Microsoft generate tremendous cash from highly skilled employees and have been able to hire at will. In Apple's announcement, the company noted it plans to create 20,000 jobs "through hiring at existing campuses and opening a new one" and contribute $350 billion to the economy over the next five years. In the long run, 20,000 jobs are a drop in the bucket for an economy churning out 150,000-200,000 every month. Apple currently employs 84,000 people in the 50 states.
It's possible the tax bill will boost employment through secondary effects, such as higher consumer spending resulting from a stronger economy. In the end, demand spurs job creation, and many companies, including Microsoft and Apple, won't hire until they see robust opportunity. This sentiment appears to be shared by many CEOs. During a Nov. 14 CEO event, the moderator asked business leaders if they planned to reinvest any tax cut proceeds. Very few hands went up.
Cash is optionality, and that's good for Microsoft
Regardless of what Microsoft CEO Satya Nadella plans to do with any repatriated money -- pay off debt, buy back shares, hire employees, or spend on research and development -- the ability to bring back foreign-held cash is a positive for the company. Cash is optionality, and the company is now free to more effectively deploy its capital. Microsoft should be one of the biggest beneficiaries of the Republican tax bill and I expect shareholders will be rewarded, on some level, now that the tax bill is law.