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Michael Baxter

Dotcom bond bubble?

Written by: Michael Baxter on May 2nd 2013

Category: Thought for the day

I have one question today: why would an investor buy 30 year debt in Apple?

I get why Apple might want to do it. In fact it is all rather clever.  So Apple has $145 billion in cash, spread out across the world, with a trifling $45 billion sitting in the US. If it pulls its money back from overseas to find its $100 billion share buy-back, it will pay corporation tax at 35 per cent.

So far so simple, but then it starts to get clever.

Because Apple is forking out so much with its share buy-back, one assumes its share prices will be positively affected. That’s good news for staff at Apple with share options, good news indeed when they sell their share at a capital gains tax of 15 per cent, or less than half the rate of corporation tax.

And what will the shareholders in Apple do with the money they get for their shares?  Since they have bought shares in Apple, they are clearly the type who like to own stock in techs, and indeed are probably the type of folk who like Apple.  So it is not unreasonable to assume many will use their windfall to buy more shares in… well, let’s see, how about Apple?

So this too should have a positive effect on the Apple share price, which will be even more good news for employees with their options.

Then there is the logic of buying bonds. Apple is paying out such a crazily low interest rate, or coupon – the yield on the bonds issued so far is 0.5111 for three years, 2.414 for ten years and 3.883 on 30 year bonds – that for Apple it is a virtual no-brainer.

But why are investors so keen? I read that for some investors there is the buzz of having Apple bonds in their portfolio. What? It is like eating a Fray Bentos meal across the road from a Gordon Ramsey restaurant, and then boasting you have eaten at his restaurant.

What really puzzles me is buying 30 years’ Apple bonds, or iBonds. I am a fan of the company; I love my iPhone, and my wife feels slightly jealous of the affection I devote to it, but I have no idea what – if anything – Apple will be doing in 30 years’ time.

We know that nothing lasts forever. I have mentioned here before how in 1912 the economist Alfred Marshal drew up a list of the world’s 100 largest companies; companies so mighty, that Marshal said they were almost immortal like Californian Redwoods. When in 1995 the list was re-visited by L Hannah – another economist –  it was found that of those 100 so-called Californian Redwoods, 29 had gone bust, 48 had disappeared, and only 19 were still in the top 100. But it seems to me that in the world of technology, the pace of change is much quicker than that described by Hannah. 30 years is practically an eternity – perhaps too long for even the Californian Redwoods of hi tech to survive.

Equity, I get. Even if Apple is no more in the year 2047, I think there is a very good chance it will have paid out dividends at least as great, and probably a good deal greater, than its current market cap between now and then. Shares in Apple offer hope. Thirty year Apple bonds are a guaranteed way not to make much money, and may well lose money if inflation rises, and may even lose a good deal of money if the company does not last.

But there is a wider point – actually several wider points.

First of all, it shows the absurdity of different tax rates for different activities. Corporation tax, capital gains tax, and even income tax should be the same.

Secondly, it shows the flaw in being able to offset interest on debt against tax. It encourages leverage that can create highly damaging bubbles such as the one that burst in 2008, compared to less damaging equity bubbles such as the one that burst in 2000.

Thirdly, it illustrates why we need a global corporation tax rate. It won’t happen I know. Our leaders seem more interested in getting rid of corporate tax altogether – something that surely makes no sense when companies are hoarding cash – than pushing for an international accord.

Fourthly, it shows how damaging corporate cash piles are. Apple has succumbed to shareholder pressure, and I guess other companies with substantial cash piles will follow suit. What we really want is for all this cash sitting on corporate balance sheets to be spent. Giving some of it back to shareholders is better than nothing – that is true. However, to fully benefit the wider economy, and thus the very same companies that are not spending, the cash pile needs to be invested. And if these cash holdings slosh around the economic system and finally find their way into government bonds, the only way the economy will grow is if the government uses this money that the market wants to lend to it, to stimulate the economy either directly or indirectly by funding investment.

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Tags: Alfred Marshal Californian Redwoods, apple bond, Apple bond yield

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