Silicon Valley will see limited benefits from Washington's cuts to the corporate tax rate. A shift in the government's tax policies towards overseas cash and earnings will help tech companies return capital to shareholders and fund acquisitions.
The "main story" for Apple Inc. (AAPL) , Cisco Systems Inc. (CSCO) and other IT hardware and data networking companies is the break on overseas cash, Barclays Capital analyst Mark Moskowitz wrote in a recent note. While the government had previously waited until a company repatriated cash to levy a 35% tax, it will now impose a 15.5% tax on cash earnings.
Apple has the most to gain in absolute dollars, with more than $250 billion in offshore cash at the end of the last quarter. Moody's Investors Service estimates that the iPhone maker will have about $265 billion overseas at the end of the year.
Gene Munster of Loup Ventures expects Apple to bring back $214 billion in cash and increase its share buyback by $69 billion. Even with the increased cash at its disposal, Munster suggests that Apple will stay focused on deals valued under $1 billion.
Networking power Cisco and data storage and management software developer NetApp Inc. (NTAP) have greater proportional benefits than Apple. Cisco's cash equals 36.% percent of its market cap while NetApp's is 32.9%, compared to Apple's 28%.
Cisco and NetApp will likely return cash to shareholders and make acquisitions, Moskowitz suggested. NetApp may also pay down debt.
While much of the cash that Apple and others repatriate will fund capital returns to shareholders, some will go to acquisitions. The mega-cap tech companies have about $550 billion in gross cash outside the U.S., Evercore ISI analyst Kirk Materne noted in a recent report, suggesting that the capital will drive deals.
The tax break on repatriated cash is part of a larger shift from a worldwide system that imposes a 35% tax to a territorial system that will impose less of a tax burden on income from overseas.
Starting next year companies will pay 10.5% or 13.125% on half of the income from subsidiaries outside the U.S. If they sell products or services produced in the U.S. in foreign markets, they will pay taxes of 10.5% or 13.125% -- a discount to the new 21% corporate tax rate.
Silicon Valley generally pays lower taxes than energy companies, telecoms and industrials, and will benefit less from the reduction in the corporate tax rate from 35% to 21%.
Some tech companies will make substantial gains from the reduction of the tax code. Ultimate Software Group Inc. (ULTI) has a 39.1% consensus tax rate for 2018, Materne noted in a report. The company could see a $3.50 improvement to 2018 earnings per share, on top of the $4.54 per share that Wall Street already expect Ultimate to earn.
Other beneficiaries include IT companies CDW Corp. (CDW) and Presidio Inc. (PSDO) , which have tax rates of 33.5% and 40%, respectively, Moskowitz noted. Networking company Arista Networks Inc. (ANET) has a 27% current tax rate.
The tax bill lowers the amount of interest that is deductible, from 100% under the prior code to 30% of Ebitda. The amount will further decrease after four years.
The changes in deductible interest will not affect most tech companies, which typically have manageable leverage. Even though Apple has about $100 billion in long-term debt, its interest expense is just 3.2% of Ebitda for the last 12 months.
The interest deductions could hamper private equity buyouts, as law firm Cooley LLP noted in a review of the tax plan. PE firms such as Silver Lake Partners, Bain Capital LLC, Thoma Bravo LLC and Vista Equity Partners LLC have an increasing appetite for tech investments in recent years.
The tech sector nearly lost tax deductions related to research and development. Earlier in the tax negotiations it appeared that Silicon Valley could lose tax credits for research and development. Congress had wanted to do away with the corporate alternative minimum tax, and considered eliminating the R&D credits to make up for the lost revenue. The research credits remain, although in future years companies will have to take the deductions over time.
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