Fri, 3 May 2013
Apple's record-making bond issuance was met with tremendous demand this week, but it's not our favorite large-cap tech bond idea today.
Jason Stipp: I'm Jason Stipp for Morningstar.
Apple priced a $17 billion bond deal this week, a record amount for an investment-grade offering.
Here to offer his take is Morningstar's Mike Hodel, an analyst on our equity and credit research team.
Thank for joining me, Mike.
Michael Hodel: Thanks for having me, Jason.
Stipp: There have been a lot of knocks on Apple recently, but one of them has not been about how much cash the company has. They have a pretty big cash hoard. Why are they issuing this debt?
Hodel: Well, there's a couple of reasons. So to get the stock price up, Apple has committed to returning $100 billion to shareholders over the next three years. So they've upped their dividend. They've put in a $60 billion share repurchase program. And to do that, they're going to be consuming cash here in the U.S.
Now, you look at the $140 billion or so in cash that Apple has on the books, about $100 billion of that is overseas, where they'd have to pay taxes to bring that back into the U.S. and use it for share repurchases and dividends. The remaining $40 billion they can use as they see fit. But as they're paying out this dividend and buying back stock, there is a risk that that will be depleted to a level they're uncomfortable with. So the company wants to maintain some large amount of U.S. cash, so they can do strategic things as they arise over the next few years.
The other piece of it, too, is that with interest rates being exceptionally low, this is a great time for Apple to take on some debt, bolster its U.S. cash position, and then have the ammo to buy back stock as it sees fit, to do strategic deals as it sees fit over the next couple years, and just have the flexibility that they want as a corporation.
Stipp: What's our take on Apple's credit worthiness? Obviously, a strong company with good sales prospects, good products. How do we rate them and how does it compare to what others rate them?
Hodel: So Apple is, obviously, a phenomenal credit from a balance sheet perspective, given the massive amount of cash that they have.
We've given them a AA- rating, which is a little bit lower than the major agencies. If you look at S&P and Moody's, they've rated them AA+, or in that ballpark. The biggest differentiator, we think, of our rating versus the agencies', and of Apple's rating versus other tech companies that we rate, is our moat rating. We've given Apple a narrow-moat rating. That's really based on the level of switching cost that we see behind Apple's products.
Certainly, the Apple brand and the Apple ecosystem of software and applications and devices has created some level of switching costs, but we're not yet convinced that, in a consumer market like Apple plays in, \ those switching costs have risen to the same level that you would see with a Microsoft or an Oracle or an IBM around the services and products that they sell to enterprise customers who depend on those software packages or those hardware products day-in and day-out to run their businesses.
So because of that, we've only awarded Apple a narrow-moat versus, say, Oracle or IBM or Microsoft, which we have wide-moat ratings on. And it's really that competitive advantage that we see at companies like Oracle and Microsoft versus Apple that's caused us to shade our Apple credit rating down a little bit.
Stipp: There's certainly been a big hunger for yield, and that's helped corporate issuance in a lot of ways recently. What's the pricing look like on this particular issuance? If I'm a corporate bond investor and I want to find reasonable yield at a good price, am I getting that here?
Hodel: Money has been pouring into fixed-income mutual funds and other assets over the last couple of years now. Bond managers are hungry for any sort of product they can get their hands on, and Apple is fresh meat for these guys. It's the opportunity to access a new entity, a new firm that they haven't been able to buy bonds in before. So demand for Apple bonds was absolutely tremendous this week. They were able to price $17 billion of bonds. As you say, it's a record, and they're able to do that at spreads that were comparable to other tech giants.
So, you look at the 10-year bond that Apple issued, they priced it at 75 basis points over Treasuries, which is comparable to a Google or an IBM--very, very comparable. Not quite to the level of Microsoft, which we rate AAA. The agencies also rate Microsoft AAA. They are maybe 8 or 9 basis points wide of where Microsoft 10-year paper currently trades, but still very, very favorable rates for Apple.
Stipp: So if you were looking in this space, do you think some of the wide-moat names, some of which you may have mentioned, might give you a little bit better relative opportunity?
Hodel: So among large-cap tech, our favorite name right now is Intel. Intel is a firm that we rate wide-moat. We think very highly of the advantages that Intel has carved out because of its manufacturing scale. But the pressures that have been building around the PC business have caused investors to lose their appetite for Intel.
So if you look at Intel 10-year bonds, they offer about 105 basis points over Treasuries. So about 30 basis points wide of where Apple priced its deal. Again, we think of Intel as being stronger from a competitive standpoint than Apple is. Certainly, as demand for processing power continues to grow over time, we think Intel will continue to play a very important role in the tech landscape generally over time.
Stipp: Mike, some great insights on this very big bond offering this week. Thanks for joining me.
Hodel: Thank you.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.