By John McDermott and Cardiff Garcia
Here’s a corporate bond mystery for you.
Google has $36.7bn cash on hand as of the end of March, according to its Q1 SEC filing. $16.9bn of this cash is held overseas. Which makes us question the FT’s interpretation of the news that the search engine is to issue $3bn worth of bonds:
Google has made its first foray into the bond markets, seeking to raise $3bn in an effort to boost its domestic cash reserves at a time when US corporate borrowing costs have returned to historical lows.
The world’s largest internet search engine planned to raise the money with bonds maturing in three, five and 10 years.
According to Google’s SEC filing these bonds have been priced at 1.25, 2.125 and 3.625 per cent respectively. As for the company’s official explanation: “We plan to use the proceeds to repay outstanding commercial paper and for general corporate purposes.”
Something about this doesn’t sound right. Greg Mankiw picks up the riddle in a post on Tuesday morning.
It is like reverse maturity transformation. The banking system borrows short and lends long. Google is borrowing long and lending short. (Or maybe I should call it reverse quantitative easing, as Google is also doing exactly the opposite of what the Fed has been doing.)
The Harvard professor doesn’t doubt Google’s smarts, but he does politely second-guess the strategy based on the empirical literature on the expectations theory of the term structure. A term structure that has recently deviated from the mean: the yield spread between 10-year US Treasuries and 3-month Treasury bills is high by historical standards.
Google is lending short and borrowing long, counter to the literature’s findings to date, he says.
Maybe this time is different, and past empirical regularities will not hold going forward. But ponder this question: If you had a friend with a paid-up house, would you suggest that he now take out a long-term mortgage in order to deposit the proceeds in a money-market fund? If not, does it make sense for Google to be doing much the same thing?
Tyler Cowen posits a couple of explanations. First, could this be shareholders trying to get management to accept the scrutiny of capital markets? Unlikely, he says. The voting stake of founders Larry Page and Sergey Brin slipped below 50 per cent in January but decisions like this one would surely have required their consent.
Second, Google is looking to put their cash pile to use via M&A deals. This seems plausible given its pursuit of Groupon and the Mircrosoft-Skype deal, but we obviously can’t say for sure yet.
If this is the case, then it would coincide with one of the year’s visibly incipient trends:
But as Cowen says, for a company with Google’s cash pile, tapping debt markets would imply some big potential buys. But then why such a small bond offering? Or does it plan more? Is it simply establishing a foothold — but what does that even mean?
Last year we wrote about a few other big companies (including Microsoft) playing the debt/equity arb to buy back shares and increase dividends. In other words, to juice returns for shareholders in a depressed rate environment, which obviously persists to this day. This is the kind of thing, of course, that the US tax code foolishly encourages: it raises the cost of equity financing relative to debt.
But this still seems to make little sense for Google, for some of the reasons mentioned above: its founders just about control the company, and although its Q1 earnings missed expectations because of rising expenses, its cash hoarde still kept climbing (from $35bn at the end of Q4 to $36.7bn). And frankly, the company has never appeared to be much fazed by the pleadings of analyst types to start paying a dividend or buy back shares.
Anyways, we’re miffed — so if you have any explanations of your own, please let us know.
Update (6:19pm, London time): Commenter BBB+ points out what we were going to, but, um forgot, to mention. This could also be a play by Google on the taxation of foreign profits. Greg Mankiw’s post carries an update to that effect, too.
However, the Mankiw update suggests that “almost all” of Google’s cash pile is held overseas whereas the FT reports that it’s “only” $16.9bn. So this theory explains some but surely not all of the bond issuance.
Update (3:30am, London time): Commenter Java puts forward an interesting hypothesis:
Can they pay these bonds off from cash overseas? If they can without any tax implication in the US ( which i suspect there might be) it could be a way of repatriating cash from overseas to the us without paying tax(and paying the coupon instead)
We spoke to three tax lawyers and each of them said that unless Google had found a hitherto unknown loophole this was not an option. Any money brought home to pay off the bonds would be subject to US corporate tax; the same as for any other repatriation reason.
One lawyer did tell us that the foreign reserves could be used as collateral for the US bond, up to a total of 65 per cent of the total collateral.
The reasons the lawyers speculated on were the same that the post and comments suggest: debt/equity arbitrage, hopes of a repatriation holiday, diversification of cash sources and hoarding cash for M&A deals.
Related links:
Google Plays the Yield Curve – Greg Mankiw
“Google Plays the Yield Curve” – Marginal Revolution