Comment: Apple bond enthusiasts blind to downside risks

Philip Bayley
The domestic corporate bond market went into raptures late last week over the debut of Apple Inc (rated AA+).  After briefing investors on Tuesday, Apple launched a three tranche issue with an expected total size of around A$1.0 billion, even though no tranche sizes were specified.

By Friday morning the order book had reached just under A$3.0 billion and indicative pricing had come in by five basis points on the four year fixed and floating rate tranches, launched at 70 bps over swap/bank bills, and on the seven year fixed rate tranche, launched at 115 bps over swap.

In the afternoon, Apple priced the largest true corporate bond issue yet seen in the Australian bond market. Even the seven year tranche on its own, qualifies for this title.

Apple sold A$1.15 billion of seven year bonds (priced at 110 bps over swap), A$400 million of four year bonds (priced at 65 bps over), and A$700 million of four year floating rate notes (priced at 65 bps over bank bills).

With the enthusiasm for Apple paper bringing in pricing by five bps, the deal ultimately done looks expensive against comparable pricing on Apple's US dollar denominated bonds.   

There is no doubt that the Apple issue offers a rare opportunity to acquire bonds from a very high quality corporate issuer, operating in a sector that is not represented in the Australian market.

However, the enthusiasm of investors appears to ignore some sobering considerations.

The rationale for the issue is of concern, as are prospects for future issuance and the likelihood that Apple will not maintain its credit quality.

Dealing with each of these concerns in reverse order: history shows that very highly rated corporations tend not to remain so. Credit rating agency rating migration tables show that AAA and AA rated issuers have the highest downward migration rates.

As for prospects for future issuance, Apple has issued US$50 billion of bonds since May 2013 excluding this latest issue, and is far from being effectively debt free.

With the bonds being issued to pay dividends to shareholders and fund capital buybacks because Apple can't use the US$200 billion cash pile that it is sitting on, plenty more bond issuance can be expected.

And this brings us to the rationale for Apple's bond issuance. Most of the US$200 billion of cash held by Apple is held outside of the US and cannot be repatriated without incurring a substantial tax liability.

Issuing debt as a tax dodge is rarely a good idea and this is likely to be especially so when it is being issued on this scale.

One can't help but think about a AAA rated entity that was a prolific issuer of bonds in the Australian market in the years prior to the GFC. Because there was so much supply, its issuance was typically priced wide of comparable issues by the major banks, which during part of that period were rated AA-, before moving up to AA.

The successor entity is today known as GE Capital Australia Funding Pty Ltd, and its bonds are now rated AA+.

Just as Apple Inc was about to brief local investors on Tuesday, Moody's Investor Service came out with a comment that the devaluation of the Yuan was a credit negative for Apple. Moody's noted that China accounted for more than 20 per cent of Apple's total sales in the last quarter and is its largest market outside of the Americas.

If the yuan devalues, the cost of Apple's products in China goes up, all other things being equal. Moody's views this problem as being manageable, especially given the appreciation of the US dollar that has been underway for a while now, but is concerned about a weaker Chinese economy that may not rebound despite the extraordinary efforts of the Chinese government to restart rapid growth.