Tuesday, May 17, 2011

Why Google is selling bonds

Yesterday Google decided to sell $3 billion worth of bonds, despite having $37 billion in cash. Greg Mankiw wonders why they would do this when the yield curve is very steep by historical standards. One of his readers suggests that it is because most of Google's cash is held offshore, and would be subject to a punishing tax rate of 35% if repatriated; Google is essentially betting that the corporate tax rate will be lower in the future, at which time they can repatriate the cash and pay back the bonds and come out ahead.

I would like to suggest yet another reason. First, I would note that the bonds Google is selling are of relatively short maturity: $1 billion of 3-yr bonds, $1 billion of 5-yr bonds, and $1 billion of 10-yr bonds. That gives you an average maturity of just over 5 years. To simplify the analysis, Google is effectively selling something like $3 billion of 5-yr bonds. Thanks to its AA- credit rating, Google is able to borrow at a rate that is about 50 bps on average above what the U.S. Treasury would pay for similar maturity bonds. That's not a terribly low spread, and the yield curve is relatively steep, but it is a relatively low spread over extremely low 5-yr Treasury yields, as the chart below demonstrates.

In short, Google is borrowing $3 billion at a yield that is just about the lowest yield in modern U.S. history. The Federal Reserve has been trying very hard to convince the world to borrow dollars, and Google is simply taking its advice. If corporate tax rates decline in the next year or so—a bet that looks more attractive almost every day—and if the economy improves and interest rates rise, Google will have executed a very profitable trifecta: it could repatriate its cash at a lower tax rate and buy back its bonds at a discount. And even if none of this works out, Google's cost of borrowing $3 billion will only be about 2.3%, which in an historical context is not very much. And if the dollar continues to depreciate, then borrowing dollars today in order to keep cash abroad will also prove to be a profitable strategy.


Benjamin Cole said...

Google can borrow money for five years at 2.3 percent?

I assume these are sophisticated lenders.

So, where are the inflation fears?

Time will tell if Google timed the borrowing correctly---rates may go down even more. The Japan scenario could still be in the cards for the USA.

With the end of QE2, the DJIA is going down, commodities have tanked, unit labor costs are still going down, and real estate is going down.

The United States of Japan?

Rick said...

Why isn't the other side of the question explored? Why would anyone lend Google $1 billion for 5 years at 2.3%?

acrossthecurve said...

just another handout to a corporation that would never need it or get it in the glory days.

we hand out favor after favor to google, jpm or any massive corporation that we think we can pay for its loyalty. But I and any student of Machiavelli knows, you can't buy loyalty. These "too big to touch" companies will leave this country in a heart beat if they can pay lower taxes and make more money elsewhere.

Charles said...

At the end of 2010 they had $3.5B in short term debt on their balance sheet which was not there at the end of 2009. They seem to be stretching it out on relatively favorable terms, possibly by going directly to the bond market. Perhaps they think short term rates will rise sooner rather than later.

Scott Grannis said...

Google was able to borrow at that low rate because that's more than it costs Treasury to borrow. Investors are hungry for yield. Treasury yields set the bar for everyone; all corporate debt is priced off Treasuries. The better question: why is Treasury able to borrow so much at such low rates?

Benjamin Cole said...

Google can borrow at 2.3 percent as lenders do not believe in inflation.

BTW, OT, but fun.

Wal-Mart has had eight straight declining quarters of same store sales. They blame gas prices, they blame the economy, they blame everybody but themselves.

Wal Mart stock, btw, is trading for about where it did 10 years ago.

Now, this:

Target Corp. said Thursday that its April sales at stores open at least one year rose 13.1%. Analysts, on average, had expected same-store sales to rise 13.2%, according to Thomson Reuters. Net sales for the four weeks ended April rose 13.7% to $4.87 billion

I sense the Wal-Mart model, like the Sears model of yore, has passed its prime. Dollar stores are everywhere (with great prices btw). Other retailers have better product mix.

Daniel said...

Your post was just tweeted by Jim Cramer!