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What the Repatriation Tax Cut Could Mean for Investors

Earnings

By Carmine DiCesare  |  February 8, 2018

Sam Mannai, Analytics Consultant, and Nicholas Buco, Consultant contributed to this article

In early November, the GOP released details on the much-anticipated Tax Cuts and Jobs Act. Key provisions of the bill include reducing the number of individual tax brackets from seven to four, cutting taxes on pass-through businesses to 25%, doubling of estate tax exemptions, cutting the corporate tax rate from 35% to 20%, and adding a one-time tax on repatriated assets of 12% for cash and 5% for illiquid assets. A version of the bill was passed by the House of Representatives on November 16 and another by the Senate on December 3. Congressional Republicans are now in the process of reconciling these bills for presidential approval.

Not surprisingly, Wall Street has focused on the reduction in corporate tax rates and the repatriation of assets held overseas, namely cash. This is because U.S. domiciled companies have earned record profits overseas and have kept those earnings abroad to avoid paying the 35% U.S. rate.

The Apple Example

One of the best examples of this phenomenon is Apple (AAPL-US), a company that (according to FactSet’s GeoRev data) currently derives over 60% of its revenue outside the U.S. As of the company’s latest annual report (data for September 30, 2017), Apple had accumulated $268.9 billion in cash and marketable securities on its balance sheet. Of that, $252.3 billion is strategically stashed offshore, representing billions in tax savings. As seen in the chart below, as foreign sales have increased, so has the cash balance held by Apple.

 

With the current 35% repatriation tax rate, it would cost the iPhone maker $88.3 billion in taxes to bring its entire offshore position back to the U.S,. crippling its balance sheet and leaving it with a total of $163.9 billion. Under the proposed 12% rate, Apple would still have $222.0B after taxes, a significant amount of capital that management can utilize for a variety of purposes.

Realistically Apple would not repatriate its entire “cash” position, which is constructed of both long- ($194.7 billion) and short-term ($53.9 billion) marketable securities but only $20.3 billion of cash. According to CFO Luca Maestri, 94% of this position is held overseas. In the table below are four hypothetical scenarios for Apple repatriating its cash and short-term marketable securities position (in millions) at the 12% rate. Most likely, it will not touch its long-term marketable securities. Each cash asset position mentioned above (cash, ST marketable securities, and LT marketable securities), is multiplied by .94 to approximate how much of each is in offshore accounts:

Symbol Cash Overseas ST Marketable Securities Overseas LT Marketable Securities Overseas 25% Repatriated & 12% Tax Rate 50% Repatriated & 12% Tax Rate 75% Repatriated & 12% Tax Rate 100% Repatriated & 12% Tax Rate
AAPL $19,071.7 $56,253.6 $183,031.2 $16,571.6 $33,143.1 $49,714.7 $66,286.3

 

Using the 2004 Tax Holiday for Comparison

Current estimates put the aggregate balance of cash held overseas by U.S. companies, with the purpose of tax avoidance, at $2.5 trillion. A permanent reduction in the corporate rate and one time repatriation rate would, in theory, result in a sizable amount of that cash coming back to U.S. soil. But what would the cash be used for once it is back in U.S. coffers? For clues on how companies will put this cash to use, an examination of the 2004 tax holiday (the only other time there has been a break for repatriated assets) may provide some insight.

The 2004 tax holiday, which was part of the American Jobs Creation Act, allowed qualifying companies to repatriate cash held overseas at 5.25%. This resulted in $312 billion dollars being brought back from overseas according to the Congressional Research Service. The idea was that the cash was to be pumped back into the economy via investment and job creation.

To illustrate how these assets were used, we pulled the constituents of the S&P 500 as of December 31, 2015, into FactSet’s Universal Screening application. Then we brought in special dividends, share buybacks, and CAPEX data for 2003-2005 to see whether there was an observable spike to indicate where repatriated earnings were directed.

From 2003 to 2005, 63% of the S&P 500 constituents increased their annual dividends. In 2003, a combined $30.3 billion in special dividends was paid to shareholders of S&P 500 constituents; this figure jumped to $179.4 billion in 2004, an increase of 492%. In 2005, aggregate special dividends fell to $49.2 billion. Of this $179.4 billion, a collective $149.8 billion (84%) came solely from companies in the GICS Information Technology sector. Notable companies such as Microsoft (MSFT-US) and Motorola (MSI-US) contributed the most to this total. Financials and Healthcare were also top contributors.

Top 10 Special Dividend Contributors in 2004+2005

Company Symbol Company Name Spec. DPS 2003 Spec. Div $ 2003 Spec. DPS 2004 Spec. Div $ 2004 Spec. DPS 2005 Spec. Div $ 2005 Spec. Divs $  2004 + 2005
  Sum   $1,710.7   $175,626.9   $45,916.1 $221,543.01
                 
MSFT Microsoft Corporation 0.0 $0.0 3.00 $130,152.0 0.00 $0.0 $130,152.00
AXP American Express Company 0.0 $0.0 0.00 $0.0 6.27 $34,441.3 $34,441.34
MSI Motorola Inc. 0.0 $0.0 14.45 $19,645.2 0.00 $0.0 $19,645.20
ABT Abbott Laboratories 0.0 $0.0 2.85 $17,797.6 0.00 $0.0 $17,797.56
CAR Cendant Corporation 0.0 $0.0 0.00 $0.0 11.00 $4,547.3 $4,547.26
ASH Ashland Inc. 0.0 $0.0 0.00 $0.0 12.61 $3,673.7 $3,673.74
BEAM Fortune Brands Inc. 0.0 $0.0 0.00 $0.0 5.41 $3,253.8 $3,253.79
USB U.S. Bancorp 0.0 $0.0 0.42 $3,123.5 0.00 $0.0 $3,123.46
CTX Centex Corp. 3.1 $1,710.7 5.29 $2,625.7 0.00 $0.0 $2,625.67
LB Limited Brands Inc. 0.0 $0.0 1.23 $2,283.0 0.00 $0.0 $2,282.99


A similar pattern can be observed with share repurchases. In 2003, $115 billion worth of shares were bought back from shareholders; this number grew to $202.7 billion and $336.5 billion in 2004 and 2005, respectively, a cumulative increase of 193%.

Top 10 Share Buyback Contributors in 2004 and 2005

Company Symbol Company Name 2003 $ Share Repurchases 2004 $ Share Repurchases 2005 $ Share Repurchases $ Share Repurchases 2004 + 2005
  Sum $51,517.7 $57,122.8 $103,009.5 $160,132.3
           
XOM Exxon Mobil Corporation $5,899.2 $9,951.1 $18,220.6 $28,171.7
MSFT Microsoft Corporation $2,764.0 $2,629.1 $17,417.3 $20,046.4
CSCO Cisco Systems, Inc. $7,400.0 $10,770.0 $8,029.5 $18,799.4
INTC Intel Corporation $4,000.0 $7,514.9 $10,635.9 $18,150.8
C Citigroup Inc $2,413.2 $1,799.1 $13,541.9 $15,341.0
IBM International Business Machines Corporation $4,403.0 $7,270.0 $7,671.3 $14,941.3
PG Procter & Gamble Company $0.0 $0.0 $12,668.9 $12,668.9
BAC Bank of America Corporation $9,612.7 $6,288.6 $5,790.5 $12,079.1
PFE Pfizer Inc. $13,025.6 $6,681.1 $3,810.2 $10,491.2
DELL Dell Inc. $2,000.0 $4,218.9 $5,223.5 $9,442.4

 

On the investment side, S&P 500 companies spent a combined $372 billion on capital expenditures in 2003, increasing their investment to $385 billion in 2004 and $436 billion in 2005.

While there was an increase in capital expenditures, the enormous spikes in special dividends and share buybacks indicate that a large portion of repatriated assets were used to reward shareholders directly.

To apply these observations to today’s environment, we can look at how the percentages of revenues derived overseas, as well as cash balances, have changed since 2004. In 2004, companies in the S&P 500 derived an average of 51.2% of total revenue from the U.S. with an average of 20.2% coming from foreign sources. The same companies carried an average of $7.5 billion in cash on their balance sheets. The breakdown by sector shows tech, materials, energy, industrials, and healthcare leading the way by percentage of non-domestic revenue.

GeoRev % s in 2003+2004

  Company Symbol United States 2003 Rev % Europe 2004 Rev % Asia 2003 Rev % Ex U.S 2003 Rev % United States 2004 Rev % Europe 2004 Rev % Asia 2004 Rev % Ex U.S 2004 Rev %
Average   43.0% 8.3% 5.6% 18.1% 51.2% 9.2% 6.3% 20.2%
  10 Energy Average 39.6% 8.0% 4.8% 25.9% 41.8% 8.0% 5.0% 27.1%
  15 Materials Average 48.3% 15.6% 9.5% 33.0% 46.8% 18.0% 9.6% 34.5%
  20 Industrials Average 58.7% 12.6% 6.0% 24.3% 59.4% 12.6% 6.8% 25.5%
  25 Consumer DiscretionaryAverage 59.5% 7.0% 2.8% 12.9% 57.0% 7.1% 2.7% 13.0%
  30 Consumer Staples Average 57.0% 11.2% 5.0% 21.4% 57.3% 12.7% 5.3% 23.7%
  35 Health Care Average 47.6% 9.2% 4.7% 16.8% 46.6% 10.0% 5.0% 17.8%
  40 Financials Average 4.8% 0.5% 0.6% 1.3% 55.5% 3.6% 3.4% 10.0%
  45 Information Technology Average 34.6% 14.5% 16.4% 35.5% 33.5% 14.7% 17.1% 36.7%
  50 Telecommunication Services Average 50.0% 0.0% 0.0% 0.0% 50.0% 0.0% 0.0% 0.0%
  55 Utilities Average 66.7% 1.1% 0.7% 5.1% 64.5% 1.0% 0.5% 4.2%
  60 Real Estate Average 13.6% 0.5% 1.0% 3.0% 76.7% 0.6% 1.1% 6.6%

 

As of 2016, the share of non-domestic revenue had increased to 30.2% since 2004, an increase of 46%, with average cash balances increasing 16.5% to $8.8 billion. Financials, tech, healthcare, and the energy sectors still led the averages in non-domestic revenue and cash.

GeoRev %s and Cash in 2016

  Company Symbol United States 2016 Rev % Europe 2016 Rev % Asia 2016 Rev % 2016 Ex U.S Revenue % 2016 Cash Position 
Average   69.8% 11.4 10.9% 30.2% $8,831.3
  10 Energy Average 74.9% 7.9 6.4% 25.7% $6,295.9
  15 Materials Average 53.7% 17.5 14.7% 46.5% $2,000.2
  20 Industrials Average 67.0% 12.3 10.4% 33.6% $3,631.6
  25 Consumer Discretionary Average 72.4% 12.1 8.8% 27.6% $3,154.5
  30 Consumer Staples Average 66.5% 12.8 9.2% 33.3% $5,004.5
  35 Health Care Average 67.2% 15.7 10.9% 33.2% $6,197.2
  40 Financials Average 78.9% 8.0 5.4% 18.3% $30,746.1
  45 Information Technology Average 45.8% 16.3 29.9% 54.9% $13,119.6
  50 Telecommunication Services Average 97.7% 0.3 0.4% 3.0% $4,293.7
  55 Utilities Average 95.5% 1.2 0.2% 5.2% $3,649.0
  60 Real Estate Average 91.6% 3.0 2.3% 9.0% $1,235.2

 

While history does not always repeat itself, using the 2004 tax holiday as an indicator of potential outcomes provides some insight for the possible ramifications of the recently passed tax overhaul. Based on the estimated $2.5 trillion worth of cash stored overseas for the purpose of tax avoidance, U.S companies would pay roughly $562.5 billion less in taxes under the new repatriation rate. With that figure in mind, we can assume that there will be significantly more cash distributed this time around. With the bill potentially ending up on the President Trump’s desk before the end of the year, the resulting shareholder distributions could be right around the corner.

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Carmine DiCesare

Consultant

Carmine joined FactSet in 2016 and is based in Boston.

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