Penal tax rates force US corporates to raise cheap debt
The US’s punitively high tax rates on companies repatriating overseas cash is forcing the country’s blue-chip corporates to raise cheap debt on the bond markets to help plug domestic cash-flow deficits.
In a report by Standard & Poor’s (S&P), the rating agency says tax rates as high as 35% on US companies repatriating overseas cash is deterring them from doing so, forcing them instead to replace deficits by selling bonds.
“Companies generate much of their cash flow offshore, rendering it mostly inaccessible because of the high cost of repatriation, and leaving companies with domestic cash deficits they must replace with debt issuance,” says Andrew Chang, author of the report and analyst at S&P.
“In other words, liquidity appears plentiful, but accessible liquidity is not.”
This issue throws a different perspective on the perennial problem of trapped cash, where multinational companies in particular can struggle to repatriate their hard-earned cash from certain countries they operate in.
Indeed, while the US was voted the “most efficient” country from which to repatriate company funds in a recent Euromoney survey on trapped cash, the cost to US companies of doing so is seemingly prohibitive.
This becomes an acute problem when, as S&P highlights, US companies are generating a higher proportion of their cash flow from overseas operations, and, importantly, holding record levels of cash.
S&P estimates that total cash and short-term investments held by the 1,700 US non-financial companies it rates hit a record $1.53 trillion at the end of last year – 11% up on 2012. Cheap and readily available bond-market funding has fuelled record cash balances, according to S&P, which adds that this backdrop has caused corporate indebtedness to balloon too.
For example, during the height of the 2008 to 2010 recession, S&P estimates that corporate cash balances grew by about $300 billion – thanks largely to postponing investments, aggressive cost cuts and lowering spending on share buybacks – while corporate debt levels grew by about $100 billion.
During 2011 to 2013, however, corporate cash balances continued to grow by nearly $200 billion while debt levels rocketed by about $750 billion.
Seen another way, “for every $1 of cash growth, debt increased by an astonishing $3.67 over the past three years”, says Chang.
Equally striking is that the US’s top 25 largest cash-holders under S&P’s universe – with Microsoft, Google, Verizon, Cisco Systems and Apple comprising the top five – control 43% of the total $1.5 trillion in cash balances.
In breaking this down further, S&P says it found that the top 15 cash-holders that disclosed regional cash-flow information raised cash balances by 14%, or $44 billion, during 2013. Of this growth in cash, S&P says these companies generated $45 billion overseas, indicating that their domestic cash balances actually fell $1 billion during the year.
“Most importantly, debt issuance by these 15 companies totalled $45 billion, exactly matching their overseas cash growth,” says Chang.
“These large cash-rich issuers completely exhausted their domestic cash flow and had to issue an additional $45 billion in net new debt to meet domestic cash needs, mostly in the form of increasing share repurchases.”
S&P says Cisco is a good example of this.
Its overseas cash balances have continued to grow while its domestic cash balances have remained between $3 billion to $9 billion during the past eight years, with its outstanding debt increasing during this time from $6 billion to $21 billion to “supplement its low domestic cash balances”.
Cisco’s $8 billion bond issue in February improved its domestic cash position for now, says S&P, but “we expect overseas cash growth to continue over the intermediate term outside of a tax policy reform”.
This strategy of selling bonds and using the proceeds to fulfil corporates’ domestic cash needs is, S&P argues, a form of “synthetic cash repatriation”.
“Given the limited domestic cash flow generation and reticence to repatriate cash at the current tax rate, companies are issuing debt as a form of synthetic cash repatriation,” says Chang. “The ratio of overseas to domestic cash supports this.
“These 15 issuers held 69% of their cash overseas in 2011, which subsequently rose to 72% in 2012 and to 76% in 2013. It is our view that without access to the accommodating credit markets, companies would likely not have provided the returns that shareholders have become accustomed to in recent years.”
So will this continue?
“With no near-term shift in policy or a tax holiday in sight, we expect cash growth to continue even as the Federal Reserve raises rates in 2015,” says Chang.
“On the other hand, if Congress implements a tax holiday similar to the American Jobs Creation Act of 2004, we could see a mad rush of repatriation among the cash rich, likely enriching shareholders in the process while leaving the creditors with the remaining debt.”
He concludes: “Activist shareholders should be aware: companies aren’t as rich as they appear.”