With the US Government 3-day shutdown resolved earlier this week, at least until the 8th of February, we revisited various facets of the Tax Cuts and Jobs Act of 2017 (TCJA) now a month on from its signing into law. Preliminary estimates from the Congressional Budget Office (CBO) forecast it to add a further $1 trillion to national debt over 10 years (even after macroeconomic feedback effects). This is in addition to the $10tn increase from the baseline forecast and existing $20tn in national debt. How many government shutdowns we shall see in the next decade as US national debt potentially grows to ~$31tn is anyone’s guess.
The TCJA offers huge incentives for multinational corporates; retained foreign earnings tax rate will be cut from 35% to 15.5%; the domestic earnings tax rate is being cut from 35% to 21% as well as capex tax deductibility rising from 50% to 100%. The Act also changes the U.S. from a global to a territorial tax system meaning that companies can get the benefits of tax inversion without having to move their headquarters overseas.
It is widely estimated that US corporates currently have around ~$3tn in overseas cash. Apple alone is estimated to have around $252bn of gross overseas cash. With the punitive 35% tax on retained foreign earnings (prior to TCJA) all this cash has been virtually inaccessible. This has meant that although Apple’s free cash flow and equity returns have been relatively stable for the past 5 years the company has seen its gross debt rise from nothing in 2012 to over $115bn at last reported quarter (Sep ’17) whilst gross, mostly overseas, cash has mirrored this move from a little over $100bn in 2012 to $269bn. During this period Apple’s significant issuance of long-term debt has been a transient value opportunity in the cash-rich Aa1 space.
If Apple bought all of this cash home to the US it would incur $39bn in tax; given that Apple have set aside $36bn for such matters suggests that they may repatriate most of this overseas cash. This would exhaust the need to issue the levels of debt they have been issuing in recent years. Since May 2015 we have held bonds from Apple. At that time the 3.85% May-2043s yielded 4.3%; this corresponded to an appealing 142bps spread over Treasuries which we calculated offered significant value. Fair spread for Aa1 bonds with similar duration was just 52bps according to our Relative Value Model. For illustration, a return to fair value over a 1 year horizon would have represented a gain of 18.8% in combined return and yield. The bond’s spread has since tightened 56bps to now just 86bps while we estimate fair spread of like duration Aa1 bonds are just 8bps tighter at 44bps. The bonds still offer considerable value and the likely implications of the TCJA look to make this thin-picking space of Aa1 rated corporate debt issuance even thinner as tech companies like Apple and manufacturers like Johnson & Johnson scale back their borrowing.