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China is no longer a copycat

Apple’s ‘Zaitech’

24 June 2019
Author: Michael PowerStrategist

Apple, alongside most other US multi-nationals, engages to a great degree in 'Zaitech'1 financial engineering. Has this fuelled inequity and populist resentment?

Consequences east and west

There is also a second-level consequence of this behaviour that does affect the US more broadly and directly adds fuel to the populist flame that Donald Trump is fanning. Offshore profits, even if kept offshore as cash, give America Inc (especially Big Tech) the balance sheet firepower to buy back their shares – even if those buybacks are debt-financed from within the US in what has been an era of historically low interest rates – and in the process further exacerbate the growing wealth inequality in the US.

This is not a trade balance issue per se but, in Donald Trump’s mind, it is part and parcel of the same thing: Middle America is falling behind, not just globally but in relation to the tech-rich west coast of the US and the finance-rich northeast. That middle America tends to vote Republican and the finance-rich east coast and tech-rich west coast tend to favour the Democrats only reinforces the political narrative of this logic.

Numbers tell the story

The base statistics tell most of the story:

  • 45% of America Inc’s US$2.1 trillion cash mountain belongs to Big Tech, the next largest sector is Big Pharma with 11%.
    Apple Inc. AA+ 285.1 32.8 122.4
    Microsoft Corp. AAA 142.5 14.6 93.2
    Alphabet Inc. AA+ 101.9 39.1 4
    Cisco Systems Inc. AA- 71.6 2.5 35.9
    Oracle Corp. AA- 71.6 13.1 60.7
    AT&T Inc. BBB 50.5 49 164.3
    Amgen Inc. A 41.7 2.8 35.3
    Qualcomm Inc. A 39.9 10.5 22.8
    Gilead Sciences Inc. A 36.7 5.2 33.5 Inc. AA- 31 19.9 44.1
    Total   872.5 189.5 616.2
  • Of the US$2.1 trillion cash owned by America Inc, US$1.3 trillion cash is held offshore.
  • The reason for this was connected to the previously ‘high’ US corporate tax rates, now reduced to 21% from 35%.
  • Of the Top ten holders, all are New Economy companies: Apple, Microsoft, Alphabet (Google), Cisco, Oracle, AT&T, Amgen, Qualcomm, Gilead, Amazon.
  • Except for Google, all have been increasing their gearing in recent years: Apple has borrowings of over US$120 billion, Microsoft of over US$90 billion. This has been easy to do in an era of ultra-low interest rates.
  • Since 2009, buybacks and dividends have more than quintupled to over US$1.25 trillion per annum (estimated for 2018). The base tax rate on dividends is 22% and on capital gains 20%.
  • Since 2011, America Inc’s debt has risen US$2.7 trillion, its cash has risen US$1.0 trillion meaning its net debt has risen US$1.7 trillion.
  • Since 2011, net new debt created (US$2.7 trillion) has funded buybacks (US$2.6 trillion).
  • Since 2011, over 100% of all net new share purchases have been done by companies buying back their shares. Households and institutions have been net sellers of shares.
  • The biggest three buying sectors of America Inc have been tech, financials and healthcare.
  • In the first quarter of 2018 alone, Apple bought back US$23 billion of stock. That is bigger than the market cap of 275 companies in the S&P 500.
  • From 2011 to mid-2018, the S&P500 index doubled, while the tech-heavy NASDAQ tripled.
  • Until Q3 2018, the FAANGs (Facebook, Amazon, Apple, Netflix and Google) plus Microsoft have been the main drivers of US stock market performance. In the 18 months to mid-2018, index performance has narrowed sharply to become heavily dependent on these six stocks. In the year to 10 July 2018, these six shares accounted for 98% of the gains of the S&P500 (with the top three, 71%) and 105% of the gains of NASDAQ (with the top three, 78%).

Under the Trump administration, there has been a material and positive change in the operating backdrop of many of these companies because of reductions in the US corporate tax rate from 35% to 21%. Part of the motivation behind this was to encourage those companies with offshore cash to repatriate their holdings to give workers higher wages and fund capex in the US thereby jumpstarting the economy. As a result of the tax cuts, by February 2018, workers had received a $6 billion windfall compared to shareholders getting $171 billion. Furthermore, of the top ten companies cited above, only Alphabet (Google) and Amazon are expected to increase its capex during 2018.

Summarising the America Inc. shell game

While there are qualifications to the following summary, these qualifications do not contradict the central narrative as to what has happened in the US over the past few decades.

  • Since 2011, US Big Tech has made sizeable profits, especially from its overseas activities. These profits have been largely shielded from foreign corporate taxes through sophisticated – and, according to the EU, illegal – tax planning.
  • These profits accumulated in cash that was largely held outside the US to avoid US corporate taxes being imposed upon them had they been repatriated.
  • However, consolidated balance sheets reflected this cash allowing the companies to gear up with cheap debt inside the US, especially when the interest on that debt was tax-deductible and gave tax cover to US-earned profits.
  • With these US debt borrowings, higher dividends were paid out and aggressive share buyback programmes were undertaken.
  • Until recently, it was significantly better to harvest this cash through debt-funded higher dividends or, even better, debt-funded share buybacks that at the same time, conveniently, drove the stock prices higher. And of course, the debt used to pay for the buybacks was eligible for interest deductibility. Before the additional advantage still provided by this deductibility, the dividend advantage may have been largely ‘neutralised’ by the recent cut in US corporate tax rates. The share buyback advantage has not, especially if it continues to drive up stock prices.
  • Stock prices, especially for the FAANGs plus Microsoft which have employed these tactics aggressively, have risen dramatically. The S&P500 has doubled since 2011, the tech-heavy NASDAQ Composite tripled.
  • The wealth of those exposed to the share prices of these companies – notably Big Tech managements with their share options – has risen accordingly, exacerbating the divide between America’s 1% and the majority of its ‘only-earning- wages’ workforce.

Unsurprisingly this ballooning inequality has added fuel to the fires of populism now ravaging the US.

Trump’s rights and wrongs

  • 55% of US imports from China are computers, electronics or electrical equipment.
  • 85% of these products come from foreign-owned if still China-based subsidiaries, mostly contract manufacturers like Foxconn.
  • Though its share is growing, Chinese-owned, China-based companies do not account for the lion’s share of the China-to-the-US trade.

This arrangement – that there is usually more money to be made by ‘Yankee Traders’ importing items from China than exporting American goods to China – has been the norm for most of the 234 years of the US-China trade relationship. The Economist, 30 March 2017, noted the following:

In 1784 the Empress of China set sail from New York, on the first American trade mission to China. Carrying ginseng, lead and woollen cloth, the merchants aboard dreamed of cracking open the vast Asian market. But the real profit, they found, came on their return, when they brought Chinese teas and porcelain to America. As other ships followed in its wake, the pattern became clear. Americans wanted more from China than Chinese wanted from America, and the difference was made up with a steady outflow of silver from America into China. The Empress had launched not just commercial ties between the two great countries but also an American deficit in its trade with China.

Yes, in the broadest sense, China may sell more to the US than vice versa but, as was the case in 1784, US importers as a rule have made the most profit out of the trade from China to the US. The Yankee Traders of today – Apple most famously – are, in this regard, little different from the New England trading companies of 1784.

Why then might this norm change and what would the change mean for the US?

1 Application of financial engineering techniques in Japanese financial markets since their deregulation in 1984. From Japanese 財テク (zaiteku, ‘money management’), from blend of 財務 (zaimu, ‘financial dealings’) and テクノロジー (tekunorojii, ‘technology’), the latter, from English technology.


Michael Power
Michael Power Strategist

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