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The Risky Truth about Apple’s Dividend

U.S. companies are sitting on record levels of cash, and no company is sitting on more cash than Apple (NYSE: AAPL). At last count, the tech giant sits on close to $145 billion.

Apple’s cash has drawn a lot of attention, particularly from investors clamoring to have more of that cash flow their way.

I give management credit for listening; Apple’s dividend was recently hiked 15% to $12.20 per share annually. In addition, the board increased its share-repurchase authorization to $60 billion from $10 billion – the largest single-share repurchase authorization in history.

At first glance, Apple’s dividend hike appears to be a no-brainer. On second glance? Less so.

Apple faces a bit of a conundrum: $102 billion of that $145 billion is held overseas. Taxes are an issue. If Apple were to repatriate its foreign-held cash, it would be subject to U.S. corporate income taxes.

That’s a problem, because U.S. corporate profits generated offshore are subject to U.S. corporate income taxes when repatriated (with a tax credit for taxes paid in foreign jurisdictions).

If corporate income taxes were uniform, there would be no problem. But corporate income taxes aren’t uniform.

The United States has one of the highest marginal income tax rates in the developed world. So even though U.S. corporations are able to take a tax credit for foreign income taxes paid, corporations are loathe to subject foreign profits to the higher U.S. tax rate.

This is understandable, given the wide discrepancy between the United States and the rest of the world.

 

Country

Marginal Corporate

Income Tax Rate

United States

40%

Japan

38%

France

33.3%

Australia

30%

Germany

29.5%

China

25%

South Korea

24.2%

United Kingdom

23%

Sweden

22%

Global Average

24%

Source: KPMG

Apple appears to want to rely on cash generated within U.S. borders, along with new debt, to fund its higher capital-return commitment.

As for the debt, Apple raised $17 billion in an oversubscribed offering consisting of six tranches. Bond investors were highly receptive; all but one of the tranches carry a yield lower than the dividend yield.

Apple’s bond issue was viewed as a miniscule-to-no-risk proposition. I thought it was interesting that one finance-school professor even mentioned to Forbes that “for a professional fund manager, owning Apple’s bonds won’t make you look stupid because everyone will own it.”

Hmmm, didn’t a similar sentiment prevail in Apple’s stock when its shares were trading around $700?

Granted, $17 billion isn’t a lot in the grand scheme of a company with a $400-billion market cap. But debt always increases financial risk. It’s also worth pointing out that if Apple plans on funding its ambitious return of capital with domestic cash, the risk is greater than you might think.

I say that because the domestic-cash account is growing at slower pace than the foreign- cash account. (Perhaps this is the consequence of paying a higher domestic income tax rate.)

In fact, quarter over quarter, Apple’s domestic-cash account actually dropped to $42.3 billion from $42.9 billion. Slow (or stagnating) cash growth is no small consideration, considering Apple expects to distribute a total of $100 billion in cash to its shareholders by the end of calendar 2015.

The problem of cash sitting in lower-taxed countries isn’t unique to Apple. According to a March report produced by Moody’s Investors Service, U.S. corporations held $1.45 trillion in overseas cash accounts at the end of 2012.

The tech sector accounted for over a third of that overseas cash, at $556 billion, stashed abroad. In addition to Apple, Microsoft (NASDAQ: MSFT), Google (NASDAQ: GOOG), and Cisco Systems (NASDAQ: CSCO) also have significant overseas holdings.

Moreover, it appears many of corporations are also “monetizing” their foreign cash accounts like Apple. Corporate bond issuance rocketed to $1.8 trillion last year from $600 billion in 2007, according to research firm Dealogic.

I freely admit that I clamor for dividends as much as any investor, particularly for the investment recommendations in the High Yield Wealth portfolio. But given the issues surrounding taxes, debt and foreign versus domestic cash, I’m paying closer attention to the risk of funding these dividends.