If you accept the idea that a corporation has ‘personhood’ then it’s possible a well-managed corporation can grow, if not forever, then at least for a very long time. Institutions survive changes in leadership, provided they are built on solid foundations. A good business can remain a good business a long time.
Even in an infinite universe, though, nothing can grow forever. You need energy, for starters. And for something more terrestrial like a technology business, in order to keep growing you have to keep innovating. And the trouble with innovating is that the bigger you get, the harder it is to do. Even if you manage it, you’re bound to grow less fast once you reach a certain size.
We present these thoughts for your consideration today as we try and work out why Apple Inc. has sold $17 billion in corporate bonds. The US tech giant sold $5.5 billion in 10-year bonds at an annual yield of 2.415%. In addition, it sold three-year bonds at a yield of 0.511%, five-year bonds at a yield of 1.076%, and 30-year bonds at a yield of 3.883%.
It was the second largest corporate bond offering in history. By all accounts, it was gobbled up eagerly and the company could have sold more. There were $52 billion in orders for the deal, according to the Wall Street Journal. What’s even more notable is that Apple was able to borrow at kind of rates normally reserved for sovereign governments.
There are two parts of this story we want to focus on in today’s Markets and Money. The first is whether borrowing money in the bond market is the best way to return money to shareholders. And even if it is, what does it say about a technology company that returning money to shareholders is the best use of its capital?
The second part of the story is that blue chip corporate bonds are being valued by the market equally or even less risky than ‘safe’ government bonds. This confirms our theory that blue chip companies like Apple are really neo-feudal City States that use their shares as currency. And more importantly, some of these institutions may survive the coming years in much better shape than sovereign governments.
But getting back to the first point, Apple’s bond offering may actually indicate that it’s NOT one of the companies that will be around in twenty years. In fact, it’s possible to imagine a world in which Apple isn’t even around in five years. Don’t believe us? Read on!
The dominant trend of the last 200 years has been the commodification of everything. As credit, labour, and raw materials become cheaper, everything becomes cheaper to produce. For customers, this is great. It explains why items that would have been considered luxurious or outlandish even fifty years ago can now be bought off the shelf in any major city in the world.
For producers, commodification is hell on profit margins. To survive and thrive in a world where you have lots of competition, you have to be a low cost producer. Nowhere is this truer than in the extractive industries, where there is no value-added profit margin to pad the fall of commodity prices. If you can’t dig it or drill it cheaply, you’ll be one of the first firms punished when resource prices fall.
Since it burst on to the scene in the 1980s, Apple seemed to be in an industry that defied commodification. Its devices are run on a closed operating system. Apple devices run on Apple software, and they run very well. But they don’t always play well with other hardware or software.
That hasn’t mattered much until now. Apple enjoyed the benefit of low-cost Chinese labour for the hardware. But the real value added that created such big profits for shareholders was in the software and the intellectual property. Apple’s innovation-driven profits are best captured in a phrase that became popular in the early 2000s when describing the difference between US tech companies and Chinese manufacturers: ‘We think, they sweat.’
But the hardware end of the technology business was commodified quickly. Dell and Hewlett Packard’s competition in the personal computer business caused IBM to exit that space and focus on servers and high-margin products aimed at the corporate customers. Profit margins in hardware manufacturing and retailing were squeezed by low-cost production and big box retailers.
Apple resisted this, too, with its regular cycle of product innovation and well-choreographed releases that the media ate up. Apples devices were always the ‘newest’ and had high perceived value. And, of course, they were good. The iPod and the iPhone were devices that changed how people interacted with information in digital form.
But competitive advantages in the technology sector are tough to maintain. The world changes. Today, no one is particularly dazzled by the functions of the smart phone. Outside Europe and North America, Samsung gains market share on Apple and dominates in developing markets. The handset and the operating system for it have been effectively commodified, which brings us back to Apple’s bond offering.
Growth stocks don’t spend their time borrowing money in the bond market in order to return it to shareholders. True, Apples reckons that repatriating cash from low-tax overseas jurisdictions would destroy shareholder value. It’s cheaper, or better for shareholders apparently, to borrow money at low rates and pay out shareholders that way.
But generally, you only return money to shareholders when you don’t have anything better to do with it yourself. Maybe Apple is so successful now that it’s simply doing what all businesses ought to do: return profits to shareholders. Or maybe Apple knows that in order to retain shareholders it has to pay them with dividends because it’s no longer a growth stock.
We’d go with the latter explanation. Apple will find it impossible to retain its competitive advantage in the next ten years. To do so, it must constantly roll out new devices in which its intellectual property is embodied. A very well-run company might be able to do this for a long time, and Apple has. But the competition is not idle.
This is a fact anti-corporate luddites often forget. Except when they’ve been granted pseudo-monopolies by the government, the vast majority of businesses can only survive by serving the customer. If you fail to do that well, you fail. And someone is always trying to do better than you. Unless you’re an industry where the natural barriers to entry are very high, or the artificial barriers to entry (government policy) make it impossible, you will find it hard to innovate forever. You will eventually die.
Incidentally, this is why so many of those studies that justify stocks for the long run are flawed. They exclude failed companies from the performance figures of stock markets over time. If you only track the winners over time, you’re going to have a pretty good track record. But for every long-term winner, there are thousands of corporate corpses on the side of the great road of progress.
Will Apple be one of them? Eventually. Will it happen in the next five years? It does tend to happen quickly in the technology industry. It wouldn’t surprise us one bit. But the fate of one individual share isn’t the real issue here for investors, and that brings us back to the second part of the story.
Apple is not fit for purpose in a deflationary world. You must be the kind of company that can generate high returns on capital to survive. If not, you’re not a City State. More on that tomorrow.
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