It's no secret that I'm a big fan of Apple's (NASDAQ:AAPL) strategy of financing its massive share repurchase program with debt. Not only does the Mac maker avoid repatriation taxes while delivering earnings accretion, but the whole program also comes at no net cost to the company. Apple's interest and dividend income more than covers the interest expense. Plus, by swapping out expensive equity capital for cheaper debt capital, Apple is able to reduce its overall weighted average cost of capital, or WACC.
But reducing WACC is more of an implicit cost of capital. There's another way that Apple's debt-powered repurchase program delivers explicit cost savings.
Retiring dividend expenses
As Apple repurchases and retires shares at an astounding rate, it no longer has to pay out the dividends for those shares. That translates into considerable savings on dividend expenses over time, considering how many shares Apple is repurchasing. Let's do the math.
Bonds are often quoted in current yields, which is a function of what an investor pays for the bond. So looking at current yields for Apple's paper doesn't fully capture the actual cost to Apple since its fixed-rate coupons do not change. Apple does have some floating-rate tranches, but the easiest thing to do is really to just look at Apple's financial statements.
Apple paid a grand total of $733 million in interest expense throughout fiscal 2015. This was more than covered by the $2.9 billion in interest and dividend income, but we already talked about that. At the end of fiscal 2015, total long-term debt (including current and non-current) was $56 billion, so Apple paid an average rate of about 1.3% on its debt (before taking into consideration that its debt levels rose throughout the year as it issued more bonds).
If shares are trading around $110, for example, and Apple is paying 1.3% in interest to repurchase those shares, it is effectively paying $1.43 per share to retire those shares. But right now Apple pays a total of $2.08 per share in dividends, so it realizes a net savings of $0.65 per share, in this example. Paying $1.43 to save $2.08 already sounds like a pretty good deal, but it actually gets even better from there. Interest expense is tax deductible, whereas dividend expenses are not, so Apple's after-tax savings are even greater.
Over the past fiscal year alone, Apple has retired 289 million shares outstanding, so you can see how quickly all those dividend savings add up, even if Apple does incur interest expense in order to do so. You can also see these savings manifest in the cash flow statement. Apple boosted its dividend payout by 8% in 2014 and another 11% in 2015 (these increases take effect halfway through the fiscal year), but total dividend expense increased by merely 4% in fiscal 2015 to $11.6 billion.
As if investors needed another reason to love Apple's share repurchases.