tax rate, earnings per share, dividends and cash…: (II)

lots of cash

A few days ago the Financial Times ran an article pointing out the huge amounts of cash that IT companies have been piling up over the past year.  According to the newspaper, the top ten public firms in technology have added $65 billion to their cash holdings since the market bottom last March.  Together they have about a quarter-trillion dollars on their balance sheets.  The FT points to the lack of anticipated merger and acquisition activity (anti-trust?) as one reason for the accumulation, and suggests that the industry will soon begin to buy back shares to reduce the size of their holdings.

Not all the big ten are as flush as the FT makes them seem, however.  EMC, IBM and ORCL have long-term debt that pretty much offsets the cash they have.  DELL, and to a lesser extent, AMZN, are negative working capital companies.  That is, they collect money from their customers before they have to pay their suppliers.  So they enjoy a kind of “float,” the same way that a restaurant or a hotel does.  There is at least some risk to the cash that appears on the balance sheet for this reason.  If the business slows, the cash begins to disappear as suppliers are paid.

Nevertheless, there are a number of tech firms with staggering amounts of cash and little or no debt.  They include:  AAPL, GOOG, INTC, MSFT and QCOM.

an important question:  where is the money?

As I suggested in yesterday’s post, at least some of the cash is overseas.  How much, no outside observer knows.

Oddly, as I was researching the 2004 amnesty that allowed firms to repatriate money to the US without paying much tax, I found an article that suggests that six years ago, some of the companies themselves, despite their financial control software, didn’t know where the money was, either.  And some had to postpone repatriation while they upgraded their treasury departments to create a mechanism to start the process and handle the incoming money.

Would companies like another amnesty?  An academic study that I also cited yesterday suggests they would.  Professors from Duke, Michigan and Washington conducted an internet survey on this topic.  Two-thirds of respondents said they would like a repeat of the 2004 amnesty.  The median amount anticipated to be repatriated was half of current foreign cash holdings.  Most of the money sent to headquarters would come from cash balances, though some would come from added foreign borrowing. (In the next few days, I’ll post on the limits to the confidence one can have in surveying in today’s world, and in internet surveying in particular.)

Other academic research suggests that the requirement to pay income tax on repatriated earnings does motivate companies to keep large foreign balances, and even to invest the funds in projects that will not be as lucrative as competing investments in the US.

stock buybacks

I’m not a big fan.  Maybe it’s age, but I’d prefer dividend increases.  It may be more tax efficient to buy back stock.  My objection, though, is I think every company has a compensation plan that features a policy of shifting a set percentage, say, 1% a year (but a lot more for small, fast-growing firms), of the ownership of the enterprise away from its shareholders and to its management.  I’m not sure the ordinary shareholder realizes this.  And it seems to me that most stock buyback plans retire just enough stock to offset dilution from stock options–thereby keeping this part of the compensation process from becoming evident through an ever-increasing share count.

looking at the numbers

The table below lists the big tech companies with the largest amounts of net cash (= cash and marketable securities minus long-term debt).  Although, as I mentioned above, there’s no good way to tell the location of a company’s cash, the lower the tax rate the more foreign earnings–and, I think, the larger the amount of cash parked abroad.  Note that I didn’t factor in long-term investment securities.  (You have to draw the line somewhere, and I decided I wasn’t comfortable deciding about the liquidity of firms’ non-current investments.)  You may want to do this differently, and the company financials are easily available on the Edgar site.

I also show the dividend yield, if any.  The following column shows dividend payments as a percentage of free cash flow ( = cash flow minus capital spending needs).  It gives mostly “negative” information.  That is, if the percentage is high, the company has little scope to increase the dividend, or even support the current payout in bad times.  A low percentage would be a good thing for dividend seekers, if we knew the location of the cash–i.e., whether the cash is available to be paid out.

The next-to-last column shows the stock’s pe based on consensus estimates of earnings to be reported in calendar 2010.  The final column shows what the pe would be if all the foreign-generated cash were to be repatriated and tax paid in the US.

—–stock price–cash/share—–tax rate——-divd—–divd/fcf—–pe—-pe”normal”tax

AAPL      $262            $27           27%        none         n/a           19x             21x

CSCO      $27.01        $4.20        19%         none        n/a           19x             24x

GOOG      $529           $78          22%         none        n/a            21x            25x

INTC        $23.35        $2.50        30%         2.9%      35%         12.6x         13.6x

MSFT      $30.84        $3.70       26%         1.7%       33%            14x            16x

QCOM     $37.92        $7.15        17%         2.0%      38%           18x            23x

my observations

1.  The absolute amounts of cash are huge.  They were astoundingly high percentages of the firms’ stock market capitalizations at the market bottom.  But they no longer are big enough to be a primary feature of the stocks as investments, in my opinion.

2.  The group divides into two camps:  fast growers–AAPL and GOOG; and more mature companies–INTC, MSFT and QCOM.    QCOM is somewhat of an anomaly.  The other stocks declare their growth characteristics through their pes and the presence/absence of a dividend.  QCOM hasn’t expanded much during the last half-decade and pays a dividend, yet has a higher pe than either INTC or MSFT.  This is probably due to its smaller size and its focus on mobile.

3.  GOOG seems to still be a more expensive stock than AAPL, despite the year-to-date outperformance of the latter over the former by about 40 percentage points.  AAPL’s pe is lower and its growth rate higher.  GOOG’s lower tax rate suggests more earning power outside the US, but also the potential issue (perhaps non-issue to everyone except me) of tapping overseas cash.

4.  The INTC/MSFT comparison is also interesting.  They are the two stalwarts of the “Wintel alliance” of the pc era, one the hardware genius, the other the software guru.  The market worries that time has passed both firms by.

INTC has a higher dividend yield and a lower pe, which I think expresses the market’s logical preference for a software company over its more capital-intensive hardware analogue.  Wall Street also believes, I think, that MSFT has an easier migration path away from the pc to more compact internet-centric devices than INTC, which has an obvious rival in ARM Holdings plc.  On the other hand, (I think) INTC has a much stronger management than MSFT.

INTC is paying a higher portion of its free cash flow in dividends than MSFT is, but the difference is slight.  INTC also has a much higher tax rate, indicating higher potential to tap offshore cash.

I don’t own either.  If I had to buy one, I’d pick INTC–but I would also watch very closely developments with the company’s Atom chip line and how it is faring against ARM offerings.

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