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Tax reform. Companies repatriating cash will use it to pay down debt

September 28, 2017

 

Although it is believed that it will be used to invest or buy back shares, Companies repatriating cash will use it to pay down debt. This will be a purely accounting transaction.

 

Currently, the cash companies have overseas is used to back-up debt and thus reduce borrowing cost. They “have set up ways to borrow money from their foreign subsidiaries” 1.

 

65% of companies have already indicated that they will use repatriated cash mainly to pay down debt 2, a purely accounting transaction.

 

Shares buy back will not happen, because they will destroy value. Apple has a debt of $100 Billion and cash overseas. Its shares are trading at the highest P/E in 5 years. If it uses cash to buy back shares, it will increase the risk of a significant decline thereafter.

Warren Buffet has the best formula for buybacks: it should only be done when the price of it is undervalued 3 That is clearly not the case today for Apple or the S&P 500. Thus, the right thing to do will be to pay debt.

 

Companies do not invest because they have cash. They do it based on payback.  For example, they build a factory because they expect more consumers will buy more products over the next 10 years. I spent most of my career evaluating such projects. Companies invest in countries where the public policy is not constantly changing.

 

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3- “The question of whether a repurchase action is value-enhancing or value-destroying for continuing shareholders is entirely purchase-price dependent. When companies announce buyback programs they almost never refer to an upper limit of what they are willing to pay”.

Warren Buffet, 2016 letter to shareholders

 

 

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