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U.S. Tax Reform: First-Quarter Earnings Wrap-Up and What Technology Issuers are Saying About Taxes and Repatriation

The majority of technology issuers rated by S&P Global Ratings that have large cash positions have reported earnings through the end of February. As expected, discussions with management have varied regarding the impact of the tax reform and specifically about repatriation and use of proceeds. Many issuers are maintaining, at least for now, their existing financial policies despite the newfound access to foreign cash, while others are pivoting to more aggressive financial policies by promising increased shareholder returns.

As discussed in our Feb. 8, 2018 commentary, "U.S. Tax Reform: A Negative Credit Impact Overall For The Technology Sector, Despite Expected Cash Flow Improvements," we view the tax reform as a credit negative for the technology industry overall because of the potential for more aggressive financial policies in response to greater access to overseas cash. S&P Global Ratings believes that tax reform will fundamentally alter the technology sector landscape and usher in a new world of lower cash balances and flat to lower debt levels, much of it incurred as a form of synthetic cash repatriation and used for share repurchases.

We have yet to take a ratings action on technology issuers solely based on the impact of the tax reform, as we view most of the announcements made thus far as still appropriate for the current ratings, even in cases where shareholder return plans may weaken credit metrics temporarily. In cases where issuers announced larger than expected shareholder returns, we are analyzing the impact to their credit profiles and our views on their financial policies, which may lead to rating or outlook changes over time. Lastly, we expect to hear more from management in the coming quarters regarding size and timing of share repurchases, views on debt issuances and repayments, and potential shift in merger and acquisition (M&A) philosophy. Below we discuss our views on several issuers (see table 1) in light of their earnings call comments regarding post-tax reform strategies.

Overview

  • Based on our review of earnings calls by large technology companies through the end of February, some issuers are maintaining, for now, existing financial policies through tax reform and repatriation while others are pivoting to more aggressive shareholder returns strategies.
  • We view the tax reform as a credit negative for the technology industry overall because of the potential for more aggressive financial policies in response to greater access to overseas cash.
  • We have yet to take a rating action solely based on the impact of the tax reform, but if shareholder returns exceed our expectations in relation to existing financial policies, we will review the credit for potential rating or outlook revisions.

Selected Technology Issuers Ranked By Cash Balances (Bil. $)

Company Name Rating Total Cash Funded Debt Adjusted Leverage (x)
Apple Inc. AA+/Stable
/A-1+
285.1 122.4 N.A.
Microsoft Corp. AAA/Stable
/A-1+
143.8 89.0 N.A.
Alphabet Inc. AA+/Stable
/A-1+
101.9 3.9 N.A.
Cisco Systems Inc. AA-/Stable
/A-1+
73.7 39.4 N.A.
Oracle Corp. AA-/Stable
/A-1+
71.6 60.7 N.A.
Intel Corp. A+/Pos
/A-1+
17.7 26.8 0.6
International Business Machines Corp. A+/Stable
/A-1
12.6 46.8 1.5
eBay Inc. BBB+/Stable
/A-2
11.3 10.0 0.5
Hewlett Packard Enterprise Co. BBB/Stable
/A-2
7.7 14.0 N.A.

Figures are as of most recent 10K or 10Q. N.A.--Not applicable based on S&P's leverage calculation, which nets surplus cash against debt and also adjusts for repatriation-related tax liability, operating leases, and capitive finance-related debt, among others.

Apple Inc.

Issuer comment.

Apple disclosed that it intends to become net cash neutral over time compared to its current net cash position of $163 billion. It also will pay $38 billion in repatriation-related taxes over eight years.

Our view.

Our ratings and outlook are not immediately affected by the announcement, given that no information was provided regarding timing and use of the surplus cash, although we view Apple's announcement as a potential shift in its financial policy. Apple is likely to provide further information during its second-quarter earnings call in May 2018 as part of the annual update to its capital return program.

Our stable outlook reflects our expectation that the company will maintain significant net cash balances over the next few years. However, if Apple depletes its surplus cash through shareholder returns sooner than we anticipate, while its business is still heavily concentrated in smartphone sales, it could impair our view of its credit profile. On the other hand, if Apple were to make acquisitions with some of the surplus cash, potentially strengthening its business by diversifying its revenue base, we could view that as a positive and it could potentially offset the reduced liquidity. Finally, we note that reducing cash levels to a net cash neutral position, without a large cash-financed acquisition, will take several years in our opinion given Apple's large surplus cash position today and anticipated free operating cash flow (FOCF) generation over the near term.

Microsoft Corp.

Issuer comment.

Microsoft recorded a tax charge of $13.8 billion related to the enactment of the Tax Cuts and Jobs Act (TCJA) in its fiscal second quarter of 2018. The amount represents a one-time transition tax on the deemed repatriation of deferred foreign income of $17.8 billion, partly offset by the impact of changes in the tax rate of $4 billion related to net deferred tax liabilities. Microsoft noted that the charge is provisional and based on reasonable estimates as the company had not completed its accounting for the tax effects of the tax reform as of Dec. 31, 2017.

Our view.

The tax reform significantly improves Microsoft's access to foreign cash balances as well as future earnings generated from foreign subsidiaries without additional tax liabilities beyond the $17.8 billion of deemed repatriation tax liabilities that will be payable over the next eight years. We expect the company to be less reliant on its commercial paper program as a source of liquidity.

We do not expect significant changes to Microsoft's shareholder return policy. Microsoft already has a sizeable share repurchase program, with about $33.4 billion remaining, as of Dec. 31, 2017, from its $40 billion share repurchase program approved on Sept. 20, 2016. The company reiterated that it will remain consistent in its ongoing commitment to shareholder return, while also emphasizing the importance of organic and inorganic (M&A) investments to pursue significant market opportunities. It is our view that passage of the U.S. tax reform does not change Microsoft's acquisition strategy. However, it improves the company's financial flexibility as it would not need to access the capital markets for M&A or to satisfy upcoming maturities.

Alphabet Inc.

Issuer comment.

Alphabet took a $9.9 billion charge due to the one-time transition tax on accumulated foreign subsidiary earnings and deferred tax impacts. The company also announced an $8.6 billion increase to its share repurchase authorization and that its approach to capital allocation is unchanged as a result of the tax reform.

Our view.

These developments do not materially affect our view of the company's financial risk and our 'AA+' rating on the company is unchanged. We will treat the portion of the $9.9 billion charge that is related to the transition tax as debt when calculating our credit metrics, assuming that the company will pay the amount owed over the eight-year period allowed by the reform. We believe the company's share repurchase announcement is consistent with its prior appetite for buybacks.

Cisco Systems Inc.

Issuer comment.

Cisco announced that it plans to repurchase roughly $31 billion in shares over the next 18 to 24 months, along with a 14% increase to its dividends, as a result of the tax reform. It intends to repatriate $67 billion of cash held overseas during the current quarter to partly fund the shareholder returns. The company reported a net cash position of $34 billion as of fiscal second quarter ended Jan. 31, 2018. Cisco also disclosed that tax related to repatriation of foreign earnings would total roughly $9 billion.

Our view.

We view Cisco's announcement as a shift in its financial policy, but it does not change our view of its overall credit profile. We expect cash balances to decline over the next two years given the aggressive shareholder return strategy, but we believe the company will still maintain a net cash position during this period given the expected strong FOCF generation in excess of $13 billion per year, as well as some modest level of debt repayments over time. Cisco has steadfastly maintained a conservative financial policy of having net realizable cash (defined as cash after repatriation taxes less funded debt) of $10 billion to $15 billion over time. However, with the recent announcement, we believe the company intends to become less conservative in its capital structure.

Our current outlook on Cisco is stable and reflects our expectation that its strong market position in the network equipment industry will support consistent FOCF generation and that it will maintain a conservative financial policy. We would consider a lower rating over the next two years if a shift in financial policy results in a significant depletion of its surplus cash, such that adjusted leverage exceeds the 1x area. Note that in calculating Cisco's leverage, we net against debt the portion of cash that we regard as surplus. Under the new territorial tax system, we have largely eliminated the surplus cash haircut as foreign cash will no longer be subject to repatriation tax, but add the present value of repatriation tax liability (roughly $9 billion over eight years) to its debt when calculating credit metrics.

Oracle Corp.

Issuer comment.

Oracle has yet to discuss its repatriation strategy as it held its last earnings call on Dec. 14, 2017, prior to passage of the tax reform. The next earnings call is scheduled for mid-March. However, on Feb. 1, 2018, Oracle expanded its share repurchase authorization by $12 billion, with no expiration date. Interestingly, this comes just two months after the company increased its authorization program by $12 billion, bringing its total share repurchase authorization to about $27 billion. We currently estimate its repatriation-related tax liability at roughly $8 billion.

Our view.

Oracle has a massive $72 billion cash balance that accounts for about a third of its market capitalization, but its debt load is also sizeable at $61 billion. As a result, its net cash to market capitalization is modest, at just 5%. Unlike issuers with large net cash positions, we believe companies that have both high cash and debt balances face potential credit risks because they may choose to use substantial portions of now-accessible foreign cash for shareholder returns. Depletion of cash, if not offset by some debt reduction, can raise leverage by our calculation and lead us to consider a negative ratings action. We believe companies with these types of balance sheets will have to clarify their financial policies to both equity and bond investors over the coming quarters as cash comes back on shore. We will monitor Oracle's earnings call for clues regarding its future financial policy.

Intel Corp.

Issuer comment.

Intel expects its 2018 tax rate to decline to about 14% from the current 21% area, driven by lower tax on foreign income, benefits for exporters and the continuation of the research and development credit. Intel also disclosed that tax related to repatriation of foreign earnings would total about $6 billion. Intel did not discuss post repatriation capital allocation plan.

Our view.

Intel's current adjusted leverage, post netting of surplus cash against debt, is roughly 0.6x while the current downgrade trigger is set at leverage sustained beyond 1.5x, among other factors. Our view on Intel has not changed given lack of post repatriation capital allocation plan. Similar to Oracle however, should Intel choose to use substantial portions of now-accessible foreign cash for shareholder returns, it can raise leverage by our calculation and lead us to consider a negative rating action.

International Business Machines Corp.

Issuer comment.

IBM recorded a one-time charge of $5.5 billion associated with the enactment of the U.S. tax reform. The charge encompasses several elements, including a tax on accumulated overseas profits and the revaluation of deferred tax assets and liabilities. IBM does have tax credit carryforwards to partly offset its tax liability from accumulated overseas profits. The deemed repatriation tax liability will be payable over the next eight years, which will be an obstacle to the company's FOCF over those years.

IBM has stated that the benefit of lower U.S. corporate tax rate will be offset by its broader tax base and reduced foreign tax credit utilization. It also provided guidance for ongoing operating tax rate of 16%, plus or minus 2%, which is considered low compared to many U.S. rated technology companies but higher than its effective tax rate of about 13% in 2017.

Our view.

We view the U.S. tax reform to have a slight negative impact on IBM's credit profile given the expectation for a higher effective tax rate and the deemed repatriation tax liability that will be payable over the next eight years. Still, we expect the company's leverage to remain in the mid-1x area, which we assess to be appropriate for the current rating.

While IBM did not specify, we believe most of its cash and marketable securities were related to profits from its foreign subsidiaries. As a result of the enactment of U.S. tax reform, IBM now has access to its significant cash balance and also future earnings generated from foreign subsidiaries without additional tax liabilities, which improves its financial flexibility.

eBay Inc.

Issuer comment.

eBay took a $1.9 billion charge because of the new U.S. tax treatment for the repatriation of foreign earnings (part of the $3.1 billion charge that included tax reform items other than repatriation). Of that amount, $1.4 billion is for deemed repatriation and will be paid over eight years. The remaining $500 million is for foreign withholding tax, which eBay would pay only if it repatriated the associated cash to the U.S. The company said that tax reform would provide a 1% tax rate benefit in 2018, as the benefit of the lower 21% U.S. corporate rate is mostly offset by the minimum 10.5% global intangible low tax income provision. eBay also announced a new $6 billion share repurchase authorization on top of the $1.7 billion remaining under its existing authorization and it said it would repurchase about $3.5 billion worth of stock per year over the next two years.

Our view.

We believe the impact of the tax and share repurchase announcements is modestly negative for our credit metrics, but not for the rating. We think the share repurchase announcement implies a roughly $2.5 billion reduction in cash over the next two years after factoring in our expectation for cash flow of about mid-$4 billion over that time. We expect S&P Global Ratings-adjusted leverage to increase to the 1x area from about 0.5x today. However, that leaves ample cushion over our downgrade threshold of 2x--enough for the company to pursue acquisitions and manage any operating volatility. We will treat the $1.4 billion charge for deemed repatriation as debt in the calculation of our credit metrics.

Hewlett Packard Enterprise Co.

Issuer comment.

HPE intends to return $7 billion to shareholders via share repurchases and dividends by the end of fiscal year ending Oct. 31, 2019, including a 50% increase in its dividends, given the recent passage of U.S. tax reform. During the quarter, the company took a one-time charge of $2.2 billion, which includes an estimated tax benefit of $1.8 billion related to the revaluation of deferred tax assets and liabilities, partially offset by a provisional estimate of $1 billion of transition tax expense on accumulated foreign earnings, and a $200 million benefit as a result of the liquidation of an insolvent non-U.S. subsidiary. HPE indicated that it expects its tax attributes to be sufficient to offset any cash tax charges related to U.S. tax reform.

HPE also provides guidance on its effective tax rate going forward. The company notes that since its fiscal year 2018 ended before the end of the calendar year, it will not be subject to the new foreign minimum tax for fiscal 2018, with effective tax rate expected to be 11%-15%. However, beginning in fiscal 2019, the company will be subject to the foreign minimum tax and its effective tax rate is expected to rise to 16%-20%.

Lastly, HPE noted that while it is currently biased toward capital returns, retaining an investment grade credit rating is important, and it will continue to take a disciplined approach to M&A.

Our view.

We believe that U.S. tax reform will provide HPE with improved cash management flexibility. Most importantly, it allows the company to access its substantial foreign cash balance without significant cash tax consequences.

The $7 billion shareholder return commitment is undoubtedly credit negative as compared to organic or inorganic investments to improve HPE's product portfolio. We expect HPE's cash balance, in additional to its FOCF generation over the next two years, to be sufficient to meet its shareholder return commitment. However, the company also has about $2.9 billion of debt maturities in October 2018, which we expect to be refinanced, with timing dependent on whether its share repurchases program would be accelerated.

We expect HPE's credit metrics to be appropriate for the rating as we believe the company's leverage will stay under 1.5x.