Wednesday, February 23, 2011

Time To Remove Those Cash Discounts?

It's no secret that many of America's largest companies are carrying massive cash balances. Unfortunately for basically all company stakeholders (including shareholders, employees, potential employees, governments, customers, suppliers etc.), much of this cash was earned by overseas subsidiaries. But America's tax rules require that such earnings be taxed again if that money is repatriated. As such, in their estimations of a company's intrinsic value, prudent value investors may discount the cash balances of companies which would be subject to repatriation taxes. Fortunately, there are signs that this policy may change, which could provide a boost to the intrisic value estimates of a slew of large corporations.

In Cisco's quarterly conference call last week, CEO John Chambers had some interesting comments about the future of repatriation. Cisco has $40 billion of cash versus a market cap of $120 billion, so this is an important issue for this company. Having attended meetings with President Obama geared towards rejuvenating job growth in America, Chambers is in a position to know how receptive the government is to changing the country's currently punitive repatriation taxes. Here's what Chambers had to say:

"In terms of our country's understanding of the importance of bringing back foreign earnings into our own country's investment for jobs, for plant and equipment, even for acquisitions, I think you're now seeing political leaders at all levels understand that...I think this one has well over a 60% probability of being resolved in a positive way and I do believe that people in the administration are much more receptive to this than they were just six or 12 months ago for combinations of reasons."

Such a move by the government would not be unprecedented. In 2004, the US drastically cut repatriation taxes in order to stimulate the economy. But it was a one-year wonder. Perhaps this administration has a more long-term solution in mind.

Either way, if a relaxation of repatriation taxes were enacted by this regime, whether temporary or permanent, shareholders owning companies with such large foreign cash balances (e.g. Cisco, Intel etc.) would benefit. Value investors who discount the cash holdings of overseas company subsidiaries may be underestimating the value of those companies, particularly in cases where those companies are carrying large cash balances relative to their market caps.

Disclosure: Author has a long position in shares of CSCO


Paul said...

nice food for thought as always, saj. Thanks!

by the way, how does one tell how much cash is held overseas?

Saj Karsan said...

Thanks, Paul. You can usually find the info in the notes to the financial statements. For example, for Cisco, this appears in the note related to income taxes (Note 14):

"U.S. income taxes and foreign withholding taxes associated with the repatriation of earnings of foreign subsidiaries were not provided for on a cumulative total of $31.6 billion of undistributed earnings for certain foreign subsidiaries as of the end of fiscal 2010. The Company intends to reinvest these earnings indefinitely in its foreign subsidiaries. If these earnings were distributed to the United States in the form of dividends or otherwise, or if the shares of the relevant foreign subsidiaries were sold or otherwise transferred, the Company would be subject to additional U.S. income taxes"

Paul said...


i appreciate it. I learn so much from you. Thanks again for all of your insight! :)