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Article / 28 March 2012 at 9:20 GMT

The real reason Microsoft, Dell, and Apple are hoarding cash

Matt Bolduc Matt Bolduc
Equity Analyst

Many technology companies which have been growing very rapidly overseas have accumulated massive cash balances to the apparent detriment of shareholders. While shareholders have repeatedly asked for higher cash returns on their investments, companies have been unwilling AND unable to do so without destroying shareholder wealth…here’s why.

For US companies, profits earned overseas are taxed at a much lower rate than the 35% US corporate tax rate. If the cash is repatriated back to the US, the cash gets taxed at the difference of the US and local tax rate.  So for some of these companies, it becomes quite expensive to send money back to the United States.

So why does this matter? Well for one, many of these companies have been unduly criticized for not increasing their dividends, which in this case would lead to either debt-issued dividends or needless destruction of shareholder value. For example, Microsoft has actually increased its debt load from 0 in 2008 to 12 billion in 2011, and the same can be found for Dell. Dell shareholders have also been very vocal, demaning the company starting a dividend program, but instead the company has focused on share buybacks instead.  

In chart 1, we see 5 large technology companies and their cash balances. We can see that most of these companies have balances of more than 20% of their market capitalisation, with Dell leading the way with over 50%. I have also researched approximately how much these companies hold in foreign cash balances and the approximate portion of cash generated from overseas operations. By using the percentage of operating earnings from outside the US as a proxy, we can see approximately how much cash is generated in foreign tax jurisdictions which is taxed at lower rates. We can see, again that Dell earns a huge chunk of its profits/cash from outside of the US.

Chart 1 cash percentages

Since most of these companies have disappointed investors with their low payout ratio, it is interesting to see how long these companies could pay out dividends and buy back stocks at the current rate without having to dip into the foreign-waiting-to-be-taxed cashpools.

Running out of domestic cash

We can see that Microsoft and Apple are paying a massive portion of their domestic cashflows in dividend, both around 80%. But Microsoft has been much more aggressive in its share buyback program. Therefore Microsoft is quite likely to issue more debt to continue massive its share buyback since at this rate, it will run out of domestic cash in less than 2 years (although my numbers assume zero domestic growth for simplicity). This explains the biggest reason why companies have not been increasing their dividends but have instead opted for buybacks. A dividend is difficult to stop once it has started, unlike a buyback.

While these cash rich companies appear to be hoarding cash for no apparent reason, they are actually doing it to save taxes. So if you invest in one of these companies, do not hold your breath for a 5% payout, it most likely won't happen unless the US changes its tax rules.

Mac Mac
As a finance professional living in Ireland I'm fully aware of our ability to attract US multinationals with our low rate of corporation tax. Keeping cash funds in the country of origin means they are available for reinvestment and growth opportunities in that country. Great for smaller economies such as Ireland! Ready cash means you are literally ready for the next opportunity and don't need to worry about the short supply of lending. I'm new to investing, but surely these are all positives, making for a more secure company with the ability to generate increased wealth? A strong company leads to a strong share price, so while dividends are nice in the short-term, is it not the long-term growth of the share price that potetial investors should be looking for?
Matt Bolduc Matt Bolduc
Regarding your first point: These companies do not tend to reinvest their cash in the same country anyways. They will send the cash wherever it is most profitable to do so. It has been a political argument to repatriate the cash back to the US so that the company could reinvest in the US economy. They tried a tax holiday during the Bush era and it simply did not work, it just makes company able to 'evade' taxes. Once the cash is back in the US the company can do whatever it wants with it, so where is the benefit? Actually there is a benefit to the shareholders since the company pays less taxes.

Second point: Over the long run, reinvested dividends provide most of the returns for shareholders (up to 80% according to the link below). I think your argument is just backward, strong companies will issue dividends and in the long run investors will benefit, which will then increase the share price.
Mac Mac
Thanks for the response Matt, and for the link. As I said, I'm new to investing, so still in the learning phase....
Matt Bolduc Matt Bolduc
No worries, a lot of people do not know that compounded dividends over a long period time can amount to massive returns for investors.

In any case, keep asking questions...
Mac Mac
Very true. It's too easy to just focus on the short-term gains and forget about the real gains across the long-term horizon. Thanks.


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