Why do corporations that have large amounts of cash also have signficantly sized debts?
For example, money.cnn.com says that of 4th quarter 2012 Apple has 39.8B in cash and short term investments while it has 46.9B in liabilities.
Why doesn’t it use some of it’s cash to pay off its liabilities? I can’t imagine that the cash or short term investments are making a better return than their debt payments, can they?
Sometimes cash or other short-term investments are tied up as obligations for something else, like a sinking fund might be. Or perhaps the cash is waiting for a bill to come due - Apple is very good at this, where they can collect payment for a computer something like 55 days before they have to pay their suppliers for the parts to build the computer.
But more often, it’s just an issue of having cash available at the right time. If you pay off all the debts, you may save some money in the short-term by reducing interest costs, but if you need to make an investment you’ll have to apply for more debt. That puts the banks in control of your expansion and you really don’t want your bankers deciding how you should grow your business. You also don’t want to get stuck trying to finance a deal in 2008 when lending ground to a halt.
So ultimately it’s just a cost of business in order to have the cash on hand, making you more flexible and independent.
One factor - often, they CAN’T pay down a significant portion of their debt. Much of it is to their corporate bond holders, and these days, most corporate bonds are not callable - in other words, they cannot choose to pay them off early.
Time value of money for one, inflation for another, mostly because there is no good reason to. If you have a good job and are paying your bills on time each month and you get a raise, would you spend the entire raise on paying your mortgage off a little early? Most of us would use the new money for other purposes. Since Apple is servicing its debt adequately without dipping into its cash, why spend the cash. Something could come up where it needed the cash and having flexibility and options is a good thing.
As a small business owner, 1-billionth the size of Apple, the reason we keep cash around while we have debt is because once you pay off debt, that cash is gone. You can’t do payroll with a credit card. So if you pay down your credit to the point where you have that much more open in credit, that’s all well and good. But now you don’t have that amount available to you for things that don’t accept credit, like payroll.
Yeah, but the entire $39.8 BILLION? How much could they possibly need on short notice?
Well…
There’s talk that Apple might build themselves a brand new corporate campus. That’s the kind of project that can eat up a few hundred million (or more).
Apple is also pretty active in the mergers & acquisitions world. HP recently paid nearly $12 billion for an acquisition designed to place them in the enterprise software arena. (I happen to know that example, because a post-acquisition audit of accounting records showed that they overpaid by about $5 billion. Oops!) If Apple wants to snap up the next Facebook for only a couple of billion, they want to be able to do so quickly and without getting too many banks involved.
Still, I do understand your point. It’s a lot of cash.
Apple is also publicly traded, isn’t it. Every share held by shareholders shows up as debt. If Apple were to manage to pay off all that debt they would no longer be a publicly traded company.
No the shares are not debt either in an accounting or financial sense. A company cannot payoff its equity. It can buy back shares in the open market.
And here the company can buy back its own debt generally even if it can’t call it back at par.
I think either you or Money.CNN.com is undercounting Apple’s cash by about 100 billion, although a lot of that is held overseas. They’d have to pay taxes if they brought the money back to the US, which is a big reason why they are not doing so.
Apple is planning to buy back $60 billion of their stock, the most ever for any corporation.
IANAL or finance expert, but I don’t believe that’s how stock works.
More like $5 billion.
Maybe you should do some basic research before commenting: Equity (finance) - Wikipedia
Another consideration is - how much are they paying for the debt and how much they are getting on their cash.
Cash, as reported on balance sheets, can also include stuff that’s not cash but can be turned into cash within some reasonably speedy time. We ex-accountants like to call this cash equivalents. As sort of mentioned above no company needs 39 billion today. You’re spending that kind of money the planning is months, if not years, out. They probably keep a few hundred million in the checking account to get through the week with and the rest is out working, but not so far out they can’t get to it fairly quickly.
And shares aren’t debt, they are ownership.
Here’s a simplistic analogy that might help with this idea.
Right now, I have enough cash (or cash-like assets) that I can pay off the balance of my mortgage. On the other hand, the interest on my mortgage is a whopping 3.85% fixed rate. If I keep the cash, I can buy investments with a higher rate-of-return than 3.85%, even taking taxes and inflation into account. In the long run, I’d actually lose money by paying off the debt immediately. I’d also have less cash available in an emergency.
That was the part I don’t understand as I mentioned in my OP. I don’t know what kind of cash-equivalent investments can be made that make better returns than most loans. If they are out there, someone please tell me what they are.
How about an index fund. Average rate of return on the S&P 500 over the past 10 years is around 7.8% (including dividend reinvestment.)
Yeah, but how much risk are you assuming by investing in a fund?
Mortgaging your house to buy stocks doesn’t seem like a good long-term plan for your money.
This is almost entirely incorrect.
Not one single share of Apple shows up as debt. Ownership interest in any corporation “shows up” as equity.
Being publicly or privately held has nothing to do with debt. It doesn’t even have anything to do with equity, really. The difference between a privately held share of a corporation and a publicly held share of another corporation has to do with SEC regulations. Private corporations have equity on their balance sheets just like public corporations.
As wrong as Qwakkeddup was, he did hint at the real reason. Corporations aren’t people, no matter what Mitt Romney says. Their identity is a legal fiction and all their capital holdings come from someplace. In corporate finance capital is divided between equity and debt sources, but the difference between them isn’t important the same way it is in personal finance.
To a real person, interest payments on debt is a negative thing. If you could pay off the debt and avoid the interest it would be a good thing because there’d be more left over for you. You’re your own shareholder in a sense and there’s no ‘cost’ to giving yourself the money you make.
In corporate finance, all capital has a cost. A corporation’s debt has a cost of debt (interest), and its equity has a cost of equity (dividends, etc.). It’s not in anyone’s interest to try to minimize one category vs the other. It’s in everybody’s interest to minimize the overall cost of capital.
For example, debt is generally cheaper than equity, partially because it’s tax deductible and partially because debtholders are paid first and take on less risk. But (most) corporations can’t be 90% debt financed (in the long run) because if they were, the debt would no longer be cheaper. Lenders would say “woah you’re way over leveraged, we want higher interest rates” and the corporation could raise capital just as cheaply by selling more equity.
It’s hard to wrap your head around because if you imagine yourself as a small business owner, you’re still much more like a real person. Paying yourself dividends/profit disbursements is much more appealing than paying a bank. But for a large corporation like Apple, it really doesn’t matter if they’re paying a bond holder or a shareholder. What matters is what is the cheapest way to raise capital.
So they’re not paying back their debt because it’s not inherently in their interest to.