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A corporate tax break that could benefit you
A new law lets companies bring money back from overseas at a lower tax rate this year. That could free up money for dividends and buybacks.
By Michael Brush
With the best of intentions, lawmakers in Washington, D.C., hope to create jobs by letting U.S. multinationals bring home foreign earnings this year at bargain tax rates to invest on the home front.
Many sprawling international companies based in the United States park foreign earnings abroad to postpone the tax payments they'd have to make to Uncle Sam if they transferred the money back here. Washingtons fix, known as the American Jobs Creation Act of 2004, takes away the tax obstacle.
The bad news is that it doesn't look like the law will create that many jobs, despite rosy estimates that as much as $418 billion could flow back.
The good news is that there's a way for investors to potentially make money because of the law.
Many companies poised to bring back buckets of cash also happen to be buying back stock and raising dividends aggressively. These are two signals that suggest a stock will produce above-average gains.
If companies like these -- Procter & Gamble (PG, news, msgs), Pfizer (PFE, news, msgs) and Johnson & Johnson (JNJ, news, msgs) are examples -- do in fact bring home lots of greenbacks, that means their shareholder-friendly buybacks and dividend hikes could get more intense, or last longer.
True, companies aren't supposed to use repatriated cash for buybacks and dividend hikes. And technically, they won't. But in the real world, cash is the ultimate fungible asset. Bring a little back to shore up your capital-spending budget, and what you had designated for plants and equipment is freed up for buybacks and dividends.
The rundown
Before we get to more on the investing angles, heres a quick summary of the law, thanks to Pat McConnell at Bear Stearns (BSC, news, msgs).
The act takes away a tax deferral on overseas income and lets companies bring money back within one year at a 5.25% tax rate, well below the typical 35% rate.
The money must be spent on things like capital investments in the United States, advertising, hiring and training, research and development, computers and software, licensing, acquisitions, improving financial strength and funding pension plans. The law doesn't provide hard deadlines for spending.
Forbidden uses include certain kinds of executive compensation, special dividends, stock repurchases and taxes.
Problem is, there's no provision to trace cash once it comes back. This gives companies a lot of wiggle room. So ultimately, the cash could wind up supporting any of the forbidden uses.
To find out what all this means outside of Washington, I polled the top 20 companies that can repatriate money and the analysts who cover them.
Some of these companies already have a fairly clear idea of how much to bring back and how to spend it. Eli Lilly (LLY, news, msgs), for example, wants to repatriate $8 billion to pay for new and current employees, research and capital spending. At the other end of the extreme, companies like Intel (INTC, news, msgs), Hewlett-Packard (HPQ, news, msgs), Altria Group (MO, news, msgs) and Dow Chemical (DOW, news, msgs) say they havent figured out what to do yet.
Even though there are a lot of blanks to fill in, you still get the sense that the law probably wont create too many jobs when you hear what companies will most likely end up doing. Heres a look.
Keeping it overseas
Many companies will simply continue to spend foreign earnings after taxes to build foreign operations. Dow, for example, uses a lot of natural gas to power plants making chemicals and plastics. So Dow wants plants in places like the Middle East, where natural gas costs a third or less than what it costs in the United States, says Sumit Desai, who covers Dow for Morningstar. Energy is a huge raw material for them," Desai says. "Its beneficial for them to keep production there.
Companies like Exxon Mobil (XOM, news, msgs), IBM (IBM, news, msgs) and General Electric (GE, news, msgs) do a big chunk of their foreign business in countries with higher tax rates than those in the United States. So unlike companies in places with lower taxes, these three havent been in a position to save on U.S. taxes by parking earnings overseas. They don't have huge amounts of cash built up abroad. That's also because whatever they have left over after foreign taxes, they use to fund investments abroad. Bottom line: There will probably be little or no increase in the amount of money coming home at companies like these. There is no benefit at all for us, said an Exxon Mobil spokeswoman.
Indeed, Michael Yellen, who manages the AIM Global Health Care Fund (GGHCX, news, msgs), says the figures getting bandied about for potential repatriations at each company can be misleading.
It is just an accounting figure that represents the amount of money a company has not repatriated, says Yellen. But much of that money has already been spent or invested. Its not like Pfizer has an extra $29 billion in extra cash sitting on its balance sheet.
Plenty of dough
Many companies that can now repatriate at bargain tax rates already have as much cash as they need. This makes sense, when you think about it. After all, if a company is mature enough to throw off a lot of cash abroad, chances are it's doing the same thing here. Having a little more coming back here doesnt change much.
Intel, for example, typically has around $14 billion in cash on hand, and it produces around $9 billion in cash each year. Its capital-spending budget is often well below that, ranging from $4 billion to $5 billion. I don't think repatriation matters a lot for Intel, says Morningstar analyst Jeremy Lopez.
You see the same thing in the pharmaceutical sector, which has six of the top-20 companies that stand to bring back the most money. The problem with the product pipelines at the pharmaceutical companies is not a shortage of cash, says Yellen.
At the end of the third quarter, for example, Johnson & Johnson had $9.7 billion in net cash, Schering-Plough (SGP, news, msgs) had $2.4 billion and Eli Lilly had $1.7 billion, according to Morningstar.
"They are fantastic cash machines because margins are so high and capital spending is minimal," says Yellen. Having more cash doesn't mean they will do anything much differently."
A tough task
Instead, it's getting harder to discover breakthrough drugs no matter how much money they spend. And pharmaceutical companies face other problems, like competition from generic drug makers or blockbuster products getting pulled from the market because of bad side effects.
Some analysts, however, reject the idea that more cash can't help Big Pharma. Tom Cameron, who manages the Eastern Point Advisors Rising Dividend Growth Fund (ICRDX, news, msgs), and John LaForge, a money manager with SRQ Capital in Sarasota, Fla., both think repatriated cash will bring more buyouts of small biotech companies.
The prime targets: Smaller companies with late-stage, lifesaving drugs as opposed to "lifestyle" drugs that do things like relieve pain or improve sexual performance, says LaForge. The reason: The Food and Drug Administration is taking a tougher stance on approval of drugs in the second camp. Three possible candidates, he says, are Keryx Biopharmaceuticals (KERX, news, msgs), developing diabetes treatments; Nektar Therapeutics (NKTR, news, msgs) working on inhaled insulin; and Ariad Pharmaceuticals (ARIA, news, msgs), developing cancer therapies.
Many companies will simply use repatriated earnings to cover debt or other liabilities. Its hard to see how this might bring job growth. Motorola (MOT, news, msgs) would be tempted to use repatriated funds to pay down debt, since thats a top goal at the company, says John Slack, who covers Motorola for Morningstar. Bristol Myers Squibb (BMY, news, msgs) says shoring up financial strength would be a priority. And any money that Altria brings home might go straight to claimants in various lawsuits from smokers that are pending against the company, says Steven Brooks, a fixed-income analyst at T. Rowe Price. Motorola and Altria declined to comment.
What it means for you
I've already written about how companies buying back stock tend to make good investments. So do businesses hiking their dividends in an aggressive manner.
Companies doing either of these things will likely do them even more, if they get to repatriate funds.
Yes, this would be a no-no under the American Job Creations Act. But a simple example shows why it will happen anyway. Suppose, for example, a company announces it plans to spend $200 million on equipment with repatriated funds. Money previously earmarked for that equipment can just be diverted to share buybacks or dividend hikes.
What companies on our top-20 list are also buying back shares the most aggressively? For help with that, we turned to David Fried of the Buyback Letter. He cites Exxon Mobil, Hewlett-Packard, Intel, IBM, Pfizer and Procter & Gamble. But we'll boot out Exxon Mobil and IBM as plays on the American Job Creations Act, since they've said they won't repatriate much money.
And what about top-20 companies that are raising dividends aggressively enough to make them buys? For help here, we turned to Jere Estes of the Eastern Point Advisors Rising Dividend Growth Fund. He likes GE, J&J, P&G and Pfizer, all of which are in his fund. We'll pull GE as a jobs-act play because it doesnt think it will actually bring back much more money.
| Top 20 Companies With Earnings Left Overseas | | Foreign Earngs Left Abroad* (billions) | Planned Repatriation (billions) | Stock Buyback yes/no | Amount of Buyback** | Annualized % Dividend Increase*** | Dividend Yield | | Company Name | | | | | | | | Pfizer (PFE, news, msgs) | $29.0 | n/a | Y | -3.30% | 15.9 | 3.19% | | Exxon Mobil (XOM, news, msgs) | $17.0 | minimal | Y | -2.40% | 3.8 | 2.03% | | International Business Machines (IBM, news, msgs) | $16.3 | minimal | Y | -3.20% | 11***** | 0.77% | | General Electric (GE, news, msgs) | $15.0 | minimal | Y*** | | 12.7 | 2.43% | | Merck (MRK, news, msgs) | $15.0 | n/a | Y | -0.30% | 10 | 5.46% | | Hewlett-Packard (HPQ, news, msgs) | $14.5 | n/a | Y | -4.40% | flat since 1999 | 1.61% | | Johnson & Johnson (JNJ, news, msgs) | $12.3 | $11 | N | | 14.7 | 1.74% | | General Motors (GM, news, msgs) | $11.9 | n/a | N | | flat since1998 | 5.42% | | DuPont (DD, news, msgs) | $10.3 | n/a | N | | flat since 1999 | 2.93% | | ChevronTexaco (CVX, news, msgs) | $10.1 | n/a | Y | -0.90% | 5.3 | 2.90% | | Schering-Plough (SGP, news, msgs) | $9.4 | $9.40 | N | | cut in 2003 | 1.16% | | Bristol-Myers Squibb (BMY, news, msgs) | $9.0 | n/a | N | | flat since 2003 | 4.73% | | Procter & Gamble (PG, news, msgs) | $8.8 | n/a | Y | -2.20% | 11.4 | 1.89% | | Eli Lilly (LLY, news, msgs) | $8.0 | $8 | N | | 8.7 | 2.78% | | Motorola (MOT, news, msgs) | $7.6 | n/a | N | | flat since 1997 | 1.00% | | Pepsico (PEP, news, msgs) | $7.5 | $7.50 | Y | -1.30% | 9.2 | 1.71% | | Altria Group (MO, news, msgs) | $7.1 | n/a | N | | 10.6 | 4.57% | | Intel (INTC, news, msgs) | $6.3 | n/a | Y | -2.50% | 28.7 | 1.41% | | Coca-Cola (KO, news, msgs) | $6.1 | n/a | Y | -1.30% | 9.7 | 2.41% | | Dow Chemical (DOW, news, msgs) | $6.0 | n/a | N | | flat since 2002 | 2.64% |
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*The amount for 2002, the benchmark year under the American Jobs Creation Act.
**year over year decline in share base reported in most recent quarter
***announced a $15 billion buyback 12/10/04
****over last ten years
*****over last nine years
Source: Bear Stearns, The Buyback Letter
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