A debt-free balance sheet with more cash than the combined funds of every AAA-rated U.S. company failed to win Apple Inc. the bond market's highest credit grade as the iPhone maker prepares to borrow to enrich shareholders.
Apple, which has $145 billion of cash, said yesterday it plans to use debt to help finance a $100 billion capital reward for shareholders after a 42 percent stock plunge. Moody's Investors Service and Standard & Poor's responded by ranking the company a level below their top grades, with Gerald Granovsky of Moody's citing "shifting consumer preferences" in a statement as a risk to Cupertino, California-based Apple's business.
The decisions give Apple lower ratings than Microsoft Corp., Johnson & Johnson, Exxon Mobil Corp. and Automatic Data Processing Inc., whose combined debt of $42 billion accounts for about 13 percent of their equity. Apple could borrow more than $17 billion and still maintain a ratio below that, according to data compiled by Bloomberg.
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"You have a company that's in a highly volatile industry that could have up to $50 billion of debt five or six years down the line," Granovsky, a New York-based analyst at Moody's, said in a telephone interview. "Just based on that, it didn't smell like a triple-A." Moody's accords Apple its second-highest level of investment grade, Aa1, and S&P ranks the company an equivalent AA+.
Concern that Apple's pace of sales growth is slowing were reinforced yesterday by a forecast for narrowing gross margins and sales this quarter that may miss analysts' predictions by as much as $4.9 billion. Apple had its first profit decline in a decade last quarter amid accelerating competition in mobile devices from Samsung Electronics Co.
"Apple was a high-growth company for a number of years, and when you start tapping the debt market, for whatever purpose, it tends to transition you into a more mature company," Matt Duch, a money manager who helps oversee $12 billion at Calvert Investments Inc. in Bethesda, Maryland, said in a telephone interview. "It does make you question where the company is in its cycle."
While Apple's stock decline to $406.13 has erased $276.6 billion of value since the shares reached a closing high of $702.10 on Sept. 19, the credit market has never been more receptive to investment-grade offerings. The average yield on corporate debt in the U.S. ranked higher than junk dropped to a record low 2.69 percent yesterday, according to Bank of America Merrill Lynch index data. Issuers with AA ratings can borrow at rates of less than 2 percent for about 10 years, and Apple may be able to sell debt inexpensively relative to its credit grade.
Cash Flow
"I don't expect them to come cheap," Dorian Garay, a New York-based money manager for an investment-grade debt fund at ING Investment Management in New York, said in a telephone interview.
Apple generated $48 billion of free cash in the 12 months ended March 30, more than the entire market value of payroll manager ADP. Revenue of $43.6 billion last quarter exceeds the sales that 80 percent of S&P 500 companies generate in an entire year.
"There are some competitive issues at the moment and you see that in their stock price, but that's not to say they're not going to generate good cash," Ping Zhao, an analyst at CreditSights Inc. in New York, said in a telephone interview. "Apple is about as much of a top-grade as you can get."
Apple would probably receive a "very attractive rate" for as much as $50 billion in new debt, Barclays Plc analyst Ben Reitzes wrote last month in a report.
That would aid Chief Financial Officer Peter Oppenheimer in his effort to reward shareholders without incurring what the Apple executive called "significant tax consequences" on a conference call yesterday with analysts and investors. By tapping the debt market to fund such rewards, Apple would be following the example of companies such as Microsoft and EBay Inc. to raise domestic funds while avoiding U.S. repatriation tax on overseas earnings.
Apple's return-of-capital program requires paying shareholders an average $30 billion annually, Oppenheimer said. That represents "substantially all" the company's fiscal 2012 free cash had Apple returned foreign earnings to the U.S. to be fully-taxed, he said.
Cash Hoard
The company held $94.2 billion of cash, cash equivalents and marketable securities in foreign subsidiaries at year-end, Apple said in a Jan. 24 regulatory filing.
"They have a lot of cash on the balance sheet and a lot of it resides outside the U.S.," said Jon Duensing, head of corporate credit at Smith Breeden Associates in Boulder, Colorado. Selling debt may be more cost-effective than paying the tax to repatriate those funds, he said.
Under current law, U.S. companies can defer federal income taxes on most overseas earnings indefinitely. When they do return to the U.S., they're taxed at the corporate rate of 35 percent, with credits for foreign income taxes paid. Companies paying little in overseas levies face higher U.S. tax bills upon repatriation and may save money by borrowing instead.
Apple's rating from S&P puts it in the same tier as General Electric Co. and Warren Buffett's Berkshire Hathaway Inc.
While Apple will probably maintain "excellent" liquidity, most of its revenue is generated in "highly competitive markets characterized by rapid technology evolution and short product life cycles," S&P analysts led by Martha Toll-Reed wrote in a report yesterday.
One of Apple's chief competitors is Samsung, which in March unveiled the Galaxy S4 to challenge the iPhone in the high-end smartphone market. The Suwon, South Korea-based company is the world's largest seller of handsets and relies on a strategy of using a wide range of devices. Apple, by contrast, releases a limited number of products each year.
"With consumer technology, whenever we think that this is the greatest product ever, you wait five to 10 years and that company is no longer at the top," Granovsky of Moody's said. "Triple-A is reserved to companies where we believe the business is highly stable."
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