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Technology: Awaiting the Return of Cash Stockpiles

For the technology sector, one aspect of the DBCFT looms above all: repatriation.

The five companies with the largest cash holdings overseas are all technology companies: (Apple, Microsoft, Alphabet, Cisco and Oracle). By our estimates, 41% of the total cash, much of it overseas, is in the hands of the technology sector.

The specifics aren’t in place yet, but the Republican call for corporate tax reform foresees a return of cash held overseas, kept there to avoid the unique U.S. system of taxing overseas profits. Whether those earnings will be taxed at a proposed one-time 8.75% rate envisioned under the DBCFT, or whether they would be under a different rate, there is no industry with as much potential to be affected by the repatriation aspect of tax reform as technology. (The Republican proposal also calls for a 3.75% tax on noncash assets, while President Trump has mentioned a 10% tax on repatriations.)

By our estimates, the technology sector controls more than 40% of the total corporate cash and investments, much of it held overseas. If the 8.75% rate were implemented per the House proposal, it would unleash a significant return of cash to the U.S., likely followed by sizeable share repurchases for many of these cash-rich companies. In a recent report, S&P Global Ratings estimated that a moderate tax rate of about 10% could result in bringing up to $1 trillion back to U.S. shores over several years.

Keeping that cash overseas has often led to outcomes that seem somewhat illogical. For example, technology companies with large cash piles have issued debt—interest payment on which are deductible—to buy back shares, when the cash held overseas would accomplish the same outcome without incurring interest payments, but would also incur the U.S. federal income tax rate. We have referred to that as “synthetic cash repatriation.”

When repatriation comes, we would expect to see a clearly communicated and orderly distribution of capital through share buybacks, dividends, and to a lesser extent, debt repayments. One other potential aspect: increased M&A activity, using the greater cash stockpiles under the U.S. flag.

The impact on the technology sector from other aspects of the proposal are far less than that of repatriation. In the case of the border adjustment—the loss of tax deductibility on imports but no tax on exports—we would expect it to have a negative impact on some hardware providers that manufacture their products overseas, such as Apple, whose products are mainly manufactured in China, and other device makers such as Cisco Systems and Dell. This in turn will likely result in higher prices for consumers, barring the projected adjustment in the value of the dollar.

The reduction in the overall corporate tax rate would benefit highly profitable companies in the technology sector. However, it would be coupled with elimination of various deductions that would offset much of the benefit. To the extent that cash flow is enhanced through lower tax rate, we expect it to benefit mostly shareholders in the form of share repurchases.

The elimination of interest rate deductibility for the technology sector would--as for all corporations-- raise the cost of capital for debt issuers and would incentivize companies to reduce their debt levels over the longer term. For speculative grade issuers, particularly LBOs, this would have material impact on their ability to maximize the capital structure, and to make dividend payments through recapitalization. The full deduction of capital expenses in the first year they are incurred is not seen as having a significant impact on the technology sector.