What does Apple do with it's $205B in the bank?
How much, you say? Apple’s financial statements for the year ending 26 September 2015 show $US205 Billion in cash and short / long term marketable securities (fancy finance speak for money in the bank and held in money market investments).
In fairness, they also have $64B in debt. Let’s take that off – we’re left with $141B.
Apple, like many multinationals, are once again in the news in Australia due to tax they either do or don't pay here. It was a key point of the 2016 Budget.
To put this in context, Greece’s national debt is €394B (approx. $US450B). The US national debt is $19T (trillion). Australia’s is approx. $US300B ($AU400B).
In simple terms, we have large organisations with a substantial cash balance and governments around the world with substantial debt.
In every country, the “large multinationals who don’t pay tax here” are in the news. You’d be forgiven for thinking it was only happening in your own country based on the way it’s reported. It isn’t. It’s happening everywhere.
While this isn’t just technology companies, their business model does compound the disparity. As an example, Chevron had $US13B in cash at the end of 2014 with $US28B in debt.
The Business Model
In 2015 (12 months to 26 Sept 2015) Apple did $234B in sales. It cost them $140B to deliver on those sales (whether than be the cost of building the hardware or software upgrades) with margin of $94B.
For every $1 in sales they keep $0.40 of it as “margin” ($94B / $234B). Net income (after all the bills, including tax) was $53B. For every $1 of sales, they keep $0.23 in net profit.
That’s a substantially higher margin & profit rate than just about any other industry. Why is that? It’s not because of tax. The nature of technology is you build once, and deliver an infinite number of times. Hence pricing is no longer connected to the cost of building that particularly unit.
It’s also why, at the initial stages, a technology company loses so much money – there is a period of time to find out what market exists for your product, if any, while you’re building it. If you're successful, your market is pretty much anyone on the planet who can access your product via the web, Facebook or a variety of other channels. Industrial age models could only dream of that kind of reach.
Hence once your sales volumes (the number of people paying for your product) goes up to the point you’re paying the bills such as payroll, rent, taxes (we’ll come back to that), the % you get to keep from every dollar of sales goes up exponentially. Last year after dividends, share buy backs and various other items Apple added $7B to their cash reserves.
At the end of 2014, Chevron’s assets (mining, oil & gas projects) were valued in excess of $200B. That will have come down substantially with dropping commodity prices however should be substantially above their debt numbers.
So what’s Apple’s IP (intellectual property) worth? Good question. The accounting profession is yet to come up with an effective way of valuing technology assets. Why is that? Mining has been around for several hundred years. Technology’s been in existence for less than 50. It does take time to develop valuation methods and a Master’s in applied finance to understand them.
Apple’s market value (share price * # shares on issue) when they announced results in late October 2015 was approx. $620B. Take off the net assets of approx. $120B and you’re left with an IP value of $500B. That’s a lot of money.
It’s also a figure that moves a lot. As of mid April 2016 the market value was $580B, which means, if we use this method, the IP may have dropped in value by $40B since then.
Due to the volatility it’s not a measure that’s normally used to measure asset value. It is, however, one of the few indicators we have and it’s relevant to understanding why the “tax” problem is so difficult to solve.
Who owns Apple?
It's Wall St and the shareholders and they only care about profits!
Wall St does have a huge influence on the stock price (and hence the volatility problem), that is true. The bulk of Apple’s shares will be owned by institutional investors. Who are they? In many cases they are the pension funds.
Do you have a retail pension (superannuation) fund? If so, there’s a good chance they’ll own either Apple shares or bundles of stocks that include Apple shares. If you have a 401K pension fund in the US it is virtually guaranteed to own Apple shares in one form or another.
The drop in value of $40B since October 15 will hit the value of those pension funds.
The CEO and the management team will also own a large number of shares – it’ll be a small % of the total shares however the dollar value of those shares will be significant. Chances are they’ll also have cash bonuses tied to the share price.
For the CEO and Board of Apple (and any other publically listed company), volatility in the stock price is a PR headache that consumes vast amounts of internal resources to manage. It’s a process that employs thousands of people around the world, none of whom are involved in building products or interacting with customers.
So what’s this got to do with tax?
Where is Apple’s IP? It’s owned by an Apple subsidiary in Ireland. Given its intangible that means you can’t see it which compounds the problem (Chevron’s assets are in the country where the natural resources are).
Ireland’s corporate tax rate is 12.5%. In Australia for large companies it’s 30%, in the UK it’s 20% and in the USA it’s 35%.
Hence Apple is well motivated to take profits out of countries like Australia. They’re really well motivated to keep them out of the USA.
Apple’s tax bill for 2015 globally is $19B, which is approx. 26% of pre-tax profits. It is impossible to tell from public records which country that tax bill will be paid in and when. They are paying it somewhere.
How do they do this? The Irish company owns the IP so the sales from customers go to Ireland (being the owner of the IP). There’s a very complex web of companies in the middle but that is the substance of what happens.
While you can't tell this from the public records, it is likely a large portion of the cash balance is sitting in Ireland. If they repatriate (move) this cash back to the USA, they pay tax on it, being the difference between 12.5% in Ireland and 35% in the USA. The actual maths is more complex however it is the difference between these rates that creates the motivation to shift profits between countries.
This is known as the “Double Irish with a Dutch sandwich” accounting method and it’s all perfectly legal. I’ve not worked for Apple however those multinationals I have worked for are impeccable at ensuring they are compliant with the tax rules in each country. It is safe to assume all of this is done perfectly legally.
It also means that Apple has a large amount of cash held in Ireland they literally can’t spend.
What would happen if Apple did transfer the cash back to the US?
In the first instance they would have a large US tax bill. It is impossible from outside the organisation to quantify what that would be. Let’s assume it’s a big number.
Would this impact their ability to trade and continue to build new products? Last year they spent $8B on product development and $11B on acquisitions, and still banked $7B after all that. Hence if it happened their business model would still allow them to trade.
If they did repatriate the cash, their reported profits would drop substantially. Remember that stock price volatility? This would hit their stock price very hard.
Surely not, you say. Markets behave rationally, surely they would take this into account.
On July 21st 2015 Apple announced June quarterly results, with a 33% increase in revenue and a 38% increase in net profits year over year. So what happened?
See the increase just before the results were announced? Chances are someone got hold of some news (probably on the infamous Wall St) and a certain amount of hubris kicked in. So some of this was correcting that.
What was the rest of the drop about? There’s vast amounts of commentary written on why that is which is easy to find if you’re prepared to lose several days trawling through Google.
The point is this happened with increasing profits. Paying a tax bill on repatriated cash would reduce those profits. It is safe to assume this would have a substantially negative impact on the share price.
Should that happen, what would happen to the value of all those pension funds? And the retirement funds of the millions of people using those as a vehicle to save for their retirement?
At the moment, there is very little ideological will & thus political will to address this. That does appear to be shifting.
Let's say the political will did exist. If I was in US Treasury and tasked with solving this, it would be an absolute balancing act between ensuring Apple is paying appropriate tax in the US and not tipping the stock markets into a fear cycle which would wipe trillions off the pension funds around the world. Tricky. I am glad I am not that person.
But I’m not in the US. I’m in [insert country of choice]. What’s any of this got to do with me?
It’s a good question. Apple is a very public example of a company that is well motivated, staying well and truly within the bounds of the law as it stands at the moment, to minimise its tax bill in its own country (being the US) let alone anywhere else.
In an Australian context, two of our biggest companies (Rio Tinto & BHP) are HQ'd in London. They would have done this for better access to capital and debt markets at the time. The lower corporate tax rate in the UK may also have something to do with it.
Hence the thinking behind the corporate tax rate for smaller businesses may relate to the fact they are more likely to be local vs global. A boost for them creates more capacity for local investment and local jobs.
So what's the solution?
Tax issues are always created by different tax rates in different countries for different income streams and the mix between income (salaries & company profits) tax and consumption taxes (GST, VAT, Sales Tax).
A globally consistent tax system is inconsistent with sovereign country borders. This is not going away anytime soon.
Even if Apple did increase it's tax payments from 26% up to say 30%, they would still have a substantial amount of money in the bank.
At the moment they have been buying back shares as a use of that cash.
Maybe they could setup their own bank?