Why Massive Offshore Cash Parking Means Companies Have Access To Only A Fraction Of The Record Cash Stash
Yesterday's Microsoft issuance of $4.75 billion in new debt, of which the 3 Year maturity portion priced at the lowest yield ever for a corporate bond of 0.875%, came at the pristine, and much discredited AAA rating. Yet what this little experiment revealed, in addition to confirming that the corporate bond bubble has never been greater, is that the cash on the sidelines argument used by every single permabull on CNBC is sorely lacking in some factual details. Namely, that a dollar at home is worth more than a dollar abroad, as BofA's Hans Mikkelsen puts it succinctly. Let's back up for a second: the primary reason why investors are funneling their capital in droves in tech and other companies that have key foreign operations is precisely due to the fact that while their domestic subsidiaries may be expiring, it is the foreign subs that are generating the bulk of the revenue, profit and thus, cash. Yet what very few have considered, is that repatriating his cash to the good old USA would cost companies hundreds of billions in US corporate taxes. That's right: even though companies are taxed abroad, the issue of double taxation is resolved by subtracting foreign taxes paid from the US tax liability. However, because foreign corporate taxes are typically lower there is an adverse tax consequence associated with remittance to the parent company. In other words, of the $1.2 or however many trillions in total corporate cash on balance sheets, a good 30% chunk of this belongs to Uncle Sam if these companies wish to use it for domestic IRR purposes. And yes, just so there is no confusion: using foreign cash to pay dividends or share repurchases is considered repatriation from the perspective of US tax regulations. Enter Microsoft: most of its cash resides abroad and is essentially useless for dividend purposes, unless the company wishes to see its net cash position cut substantially upon repatriation. Yet with everyone now clamoring for increased dividends and stock buybacks, the company is forced to access domestic capital markets and use that money for shareholder friendly activities. This is a capital mismatch fiasco just waiting to happen. The only possible winner out of this - Uncle Sam, who may soon order foreign cash to be repatriated over corporate pleas otherwise.
The companies most at risk by this geographic split in the value of dollars are ironically precisely the same tech companies that everyone is in love with. Bank of America explains why:
As we have highlighted, US corporations have built up significant cash holdings over many years - and in particular since the outbreak of the financial crisis. By the end of 2Q this year non-financial companies in the S&P 500 held $1tr in cashlike assets, an increase of nearly $200bn from the end of 2008. Clearly a high proportion of that cash is held by the Technology sector (36%) while Health Care holds 19% and Consumer Discretionary 14%. The increase in cash assets since 2008 is slightly more evenly distributed, as the Technology sector accounted for 33%, Industrials 28%, Consumer Discretionary 16% and Industrials (ex. GE) 15%. Lack of disclosure makes it difficult to judge the overall proportion of cash held in foreign subsidiaries (presumably less than one third), but the Technology sector is the extreme case as for example Cisco has disclosed that of $40bn in cash, $33bn, or 83% is held in foreign subsidiaries. While from a net debt perspective there is no difference between funding shareholder friendly activity with cash or new issuance, it is clear to us the presence of cash in foreign subsidiaries leads to more issuance than would otherwise be necessary, as highlighted by today’s Microsoft deal.
Our advice to all those who like blind lemmings follow the advice and chase the "cash hoard" - think, and do your homework first. If indeed over a third of the record cash holdings are foreign, they are as good as useless to shareholders. Which means that in order to be shareholder friendly, a company will need to be creditor adverse, and increase its default risk by increasing debt capital raises. Which only means that once the rate environment flips and rates rise, all the heretofore AAA and other IG companies, will suddenly be punched in the stomach as ever more capital starts flowing out in the form of interest expense. Remember - just like CDOs, today's AAA-rated deal is tomorrow toxic debt.
NetNet - buy CDS in IG/XO companies with lots of foreign cash and hedge DV01 with CDS in those companies with domestic cash, preferrably at same level. Then sit back and wait for the divergence.