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Apple’s New Business: Bonds

Investopedia logoInvestopedia 29-06-2015 David Floyd
Apple and Oracle are using their massive piles of cash to buy up corporate debt. With bond markets looking increasingly rickety, what effect could this have?© Thinkstock Apple and Oracle are using their massive piles of cash to buy up corporate debt. With bond markets looking increasingly rickety, what effect could this have?

Earlier this month, Bloomberg reported that tech giants such as Apple Inc. (AAPL) and Oracle Corporation (ORCL) were beginning to look a bit like PIMCO High Income Fund (PHK), BlackRock, Inc. (BLK), Vanguard and other heavy-duty bond investors. According to the report, these tech companies may buy up to half of a given bond issue, typically opting for investment-grade corporate debt with maturities of two to three years. Issuing companies include financial firms and leaders in other sectors, such as Exxon Mobil Corporation (XOM), Merck & Co. Inc. (MRK) and Wal-Mart Stores Inc. (WMT).

It shouldn't come as a surprise that the likes of Apple would be significant investors in corporate debt, given the huge hoards of cash these companies have. Between them, Apple, Oracle, Google Inc. (GOOG) and seven other tech whales hold over $500 billion in cash and other liquid assets, triple the level they did in 2008. Apple alone had $194 billion in cash and equivalents at the end of April, which, as Quartz points out, is more than Germany holds in foreign reserves. What exactly Apple does with that money is largely unknown; the company's asset management division, Reno-based Braeburn Capital, is hardly ever mentioned in earnings calls or anywhere else.

Apple Bonds

In a departure from its policy under Steve Jobs, Apple has begun returning some of its cash to investors. In 2012, CEO Tim Cook authorized a dividend for the first time in 17 years, acknowledging that Apple's then-$97.6 billion cash pile – the largest of any non-financial institution at the time – was, in The Wall Street Journal's words, "more than it needed to run its business." Apple's payout ratio remains modest, however, at 23.10%, as does its dividend yield, at 1.63%, according to FINVIZ.

In large part, the reason for this glut of cash and the underwhelming payout to investors is U.S. tax law. Apple and other companies hold the majority of their cash abroad in order to avoid hefty repatriation taxes that accrue when they bring their assets home. In some cases, American companies – mostly in the pharmaceutical industry – have bought or merged with foreign entities in order to switch their nationality. An example of these corporate inversions is Burger King's 2014 purchase of Tim Hortons and subsequent relocation to Canada as Restaurant Brands International Inc. (QSR).

Apple and other Silicon Valley giants are unlikely to pull similar defections, but they still want to avoid paying one of the world's highest corporate tax rates on repatriated cash. According to Bloomberg, Apple has $171.3 billion stashed in foreign subsidiaries; rather than bringing it home, the company is investing much of it in dollar-denominated corporate debt. (For more, see: Corporate Bonds: An Introduction To Credit Risk.)

Liquidity Concerns

Bond-buying by Apple and its cash-rich cohorts comes in the context of increasing uncertainty in the bond market. NYU professor and former (Bill) Clinton advisor Nouriel Roubini recently argued in an essay titled "The Liquidity Time Bomb" that all is not as it seems in the macroeconomic arena. While post-crisis quantitative easing by the world's largest central banks has created "a massive overhang of liquidity," bond markets appear increasingly illiquid.

The risk, he argues, is that a sudden shock – the Federal Reserve unexpectedly raising rates, say, or a rapid recovery in oil prices – drives fixed-income yields up and prices down. The Economistlays out the worst-case scenario: investors panic at spiking yields and attempt to sell bonds en masse; the open-ended funds that hold these bonds are unable to find buyers and panic spreads across the market, leading to another financial crisis. Ironically, the risk is in part due to regulations imposed after the last crisis. Banks used to "make markets" for bonds and thus provide some stability, but new rules make that too expensive.

Some evidence of this risk is already visible. Yields on U.S. Treasuries and German bunds, normally rock-solid, have begun swinging wildly. A flash crash in U.S. Treasuries in October 2014 prompted JPMorgan Chase & Co (JPM) CEO Jamie Dimon to write that, statistically, such an event should only happen every 3 billion years or so. Unfortunately, neither bankers nor regulators seem to think they will have to wait that long to see a repeat of similar bond-market vertigo.

So what effect does Silicon Valley's hunger for corporate bonds have on the delicate liquidity balance? Bob Michele, Global Fixed Income CIO at JPMorgan Asset Management told Bloomberg, "I actually think it adds a much-needed stabilizing force. To some extent we spend a lot of time looking at the decline in liquidity, that broker-dealer balance sheets have shrunk, that they can't give us the counterparty exposure that we once could access. But the reality is the corporate bond balance sheet now resides within the buy side—um, investors like us dominate that market. So, when we need—have needs to invest, it's nice to know that there are other counterparties out there with similar needs, or potentially selling."

Michele also doubts that these companies will sell their corporate bond holdings when the Fed funds rate rises, since these will probably continue to yield more than cash, and their cash flows will continue to be substantial in any case. (For more, see: Understanding Financial Liquidity.)

The Bottom Line

While America's corporate tax rate remains among the world's highest, cash-rich companies are likely to continue stowing foreign earnings in corporate bonds. This is an increasingly vulnerable market, with the potential to spark a larger downturn, but the possible effects of this uptick in corporate bond-buying are uncertain. On the one hand, large investors like Apple could be stepping in to fill a stabilizing role largely vacated by banks due to new regulations. On the other hand, a change in these companies' tack could send shock waves through an already woozy market. The Fed has the potential to spark such a change, but that risk might be overstated. Comprehensive tax reform, if passed, could lead companies to repatriate their cash, meaning that Congressional action – such as it is – should also be on investors' radar.

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