This week Apple Inc. (NASDAQ:AAPL) filed an automatic shelf registration with the SEC in preparation for the company’s upcoming bond issue. But should investors consider Apple’s iBonds? Let’s take a look.
Apple’s plan
Last week, Apple Inc. (NASDAQ:AAPL) announced plans to return over $100 billion to shareholders by the end of 2015. As part of this program, Apple will repurchase $60 billion of stock and pay out $11 billion in dividends.
To fund this program, Apple will be required to organize one of the largest corporate bond offerings in history. According to a report from CreditSights, Apple may need to issue as much as $55 billion in debt.
Why issue bonds when the company has $145 billion in cash and ample profits? Two reasons:
Debt is cheap: Debt is significantly cheaper to issue than equity. With interest rates at record lows, Apple Inc. (NASDAQ:AAPL) can reduce its cost-of-capital, the rate future cash flows are discounted at, and increase the value of the firm. This will unlock billions of dollars for shareholders.
Tax advantages: By funding the company’s capital return program with debt, Apple doesn’t have to repatriate any of its $100 billion in reserves held overseas. This could save the company $35 billion in taxes.
How will iBonds be priced?
According to the filing with the SEC, Apple Inc. (NASDAQ:AAPL) plans to issue two floating rate notes with maturities in 2016 and 2018. In addition, Apple will also issue fixed rate notes and bonds due in 2016, 2018, 2023, and 2043.
While the terms and size of Apple’s debt issue haven’t been determined yet, we can look at comparable securities to estimate where iBonds may be priced.
Apple Inc. (NASDAQ:AAPL) is a pretty attractive credit issuer. The company generates over $60 billion in EBITDA backed by $145 billion in cash and earned a AA+ credit rating from Standard & Poor’s. The average yield on a 10-year AA corporate bond is 2.75%, according to ValuBond.
But top-quality technology companies can borrow at even better rates.
Last week, Microsoft Corporation (NASDAQ:MSFT) announced plans to issue $1.95 billion of five-, 10-, and 30- year notes with coupon rates of 1%, 2.38%, and 3.75%, respectively. Incredibly, Microsoft Corporation (NASDAQ:MSFT) can borrow at rates nearly as low as the U.S. Treasury due to the company’s AAA rating from S&P.
Google Inc (NASDAQ:GOOG) is also a suitable comparable. While the company is rated AA by S&P, Google Inc (NASDAQ:GOOG)’s notes are priced as high-quality AAA. The yield to maturity on a three- and eight- year Google Inc (NASDAQ:GOOG) bond are 0.75% and 2.38%, respectively.
Given the friendly lending climate, expect Apple Inc. (NASDAQ:AAPL) to receive a warm reception from the debt market.
Should you buy iBonds?
While most yield-starved income investors will likely line up for a piece of Apple’s debt issue, smart investors should stay away.
The risk/reward for these corporate bonds aren’t attractive. Assume a 10-year iBond yields 2.5%. If interest rates rise to 4.5%, a real possibility, iBonds could lose nearly 20% of their value.
Lots of things could cause yields to rise suddenly: interest rates could return to historical norms, Apple Inc. (NASDAQ:AAPL)’s business could deteriorate, or inflation could pick up slightly.
In exchange for this risk, investors are only being compensated with a 2%-3% nominal yield. Your real return after inflation and taxes: roughly 0%.
In comparison, Apple equity is incredibly cheap. Backing out the cash on the company’s balance sheet, the market is valuing Apple’s entire business at less than seven times earnings. In addition to a 3% yield, equity investors also better protected against inflation.
Warren Buffett is right. Bonds should come with a warning label.
The article Should Investors Buy Apple’s ‘iBonds’? originally appeared on Fool.com and is written by Robert Baillieul.
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