Will Big Tech bungle U.S. tax cut billions?
Big-business spending depends on customer demand, not U.S. tax cuts, says S&P's Andrew Chang. "A tax change does not impact capital spending."
Apple, Google, Microsoft, and the rest — what are America's information-technology giants going to do with their tax-reform billions?
They'll pay some to shareholders, lenders, and buy other big tech companies. And that will likely make them weaker, not stronger, predicts a team of Silicon Valley- and Wall Street-based financial analysts for S&P Global Ratings, the credit-rating service that helps set the price of borrowed money.
Seriously? Won't Big Tech use the billions in foreign profits they can now bring home at much-lower tax rates to build up their businesses, hire more engineers, upgrade systems? Or at least cut prices?
Don't bet on it, says Andrew Chang, S&P primary credit analyst and a coauthor of the report.
"There is unlikely to be any meaningful change to capital spending, to research and development, to hiring people," Chang told me. After years of record profits and cheap interest rates, "companies that have a lot of cash overseas, even prior to repatriating it to the U.S., already had access to capital. If they wanted to build new foundries and factories, they would already have done so."
Things look very different to investors who collect tech-stock dividends and share-buyback payments — and for small businesses, which often use extra cash to try and expand. For them, tax cuts sure do look like good news. Since tax reform passed, the National Federation of Independent Business "Optimism Index" has hit a record high.
But for big tech companies, "capital spending depends on customer demand," Chang reiterated. "Customer demand is not likely to happen because cash comes back from overseas. A tax change does not impact capital spending." It does "give management an incentive to look for acquisitions," which enrich bankers and bosses but are of questionable long-term economic benefit.
The way credit analysts see it, yesterday's complex tax rules pushed U.S. companies to pile up cash around the world — in a kind of forced-savings plan, that turned bold CEOs into fiscal conservatives, building massive reserves. But now that the money has been suddenly freed by the U.S. government, they will most likely blow that cash, leaving themselves less protected for the inevitable costs of unexpected competition, new technologies, and market slowdowns.
Call them pessimists, but these credit-watchers are all about getting paid back, with interest; experience makes them skeptics.
Not all tech companies are the same. Here's how S&P divides the sector:
Cash-rich giants like Apple, Microsoft, and Alphabet (Google), which have far more cash than they have debt to pay down, face investor pressure to pay it out to shareholders. Apple has declared a big dividend hike, and other companies are expected to echo this in the weeks ahead. But when they do, they risk lowering their credit ratings and paying more for future borrowing, S&P says.
Companies with less cash, more debt, and lower-performing stocks — Hewlett-Packard, Micron, eBay — will feel pressure to keep investors interested by paying them money even if it means piling on more debt. For example, on Jan. 30, Juniper Networks Inc., whose stock has been trailing the S&P 500 IT Index, announced a $2 billion stock buyback plus an 80 percent dividend hike, to be funded by the return of foreign cash.
There will be mergers: Computer-chip maker Broadcom said it would need to borrow up to $100 billion to fund its proposed takeover of Qualcomm, the digital equipment maker that does design work at Penn's engineering school. Reuters says the biggest U.S. banks — BofA, Citi, JPMorgan, Wells Fargo — and private investors like KKR have already agreed to fund the deal. Bankers are gearing up for more tech M&A and fat fees.
There are clear winners from tax cuts among an older cohort of tech companies, including several around Philly. Blue Bell-based computer services provider Unisys Corp., Malvern-based equipment maker Vishay Intertechnology Inc., and Arris International PLC, which owns the former General Instrument video-equipment plant in Horsham, are among the "conservatively leveraged, profitable, U.S.-focused companies" that will benefit most from lower rates, S&P writes. Intel and Texas Instruments also expect "meaningful" cash-flow improvements, though this will likely "flow to shareholders" instead of driving down laptop or calculator prices.
Those benefits aren't likely to extend to U.S. tech companies owned by private-equity investors, such as First Data, the credit card processing giant, solar panel maker Solera Holdings Inc., or computer-security firm McAfee LLC. These companies have taken on heavy debt to enrich their private-equity owners or fund past acquisitions. The tax reform reduces the amount of interest they can deduct from future taxes, squeezing their prospects.
I ran this more-is-less scenario by one of Philly's great optimists, Richard Vague, the credit card mogul turned investor and philanthropist. Vague is researching a new book on the history of financial crises. He tells me he's concluded that banking and economic wrecks are typically provoked, not by government borrowing, but by out-of-control private borrowing sparked by cheap money and excess optimism.
Vague is not yet making any predictions on whether tax reform will feed a similar crisis — he's still crunching numbers — but he agrees with S&P that too much money can cause surprising problems in a mature economy.