Interest Rates and AAPL

  • Posted: 13 June 2009 04:55 PM

    Inevitably we will see interest rates rise (or continue to rise).

    The question is how quickly rates will rise and how aggressively the various Federal agencies (including the Fed) move to moderate the rise in rates. With unprecedented Federal deficits and and a continuing rapid rise in the national debt, interest rates will rise as the debt financing at all levels of government compete with homeowners and commercial interests for access to funds.

    Without going into details and calculations on the benefits to AAPL of rising interest rates, consider the positive contributions to Apple’s bottom line on rising returns on about $30 billion dollars and cash and equivalents.

    Forget (for a moment) AAPL’s GAAP results. The company is accruing earnings and piling up on cash ahead of GAAP results (and aside from GAAP results) due to deferred revenue accounting on rising iPhone sales and deferred revenue recognition on other items such as MobileMe and AppleCare.

    Add to this cash velocity flowing through Apple’s coffers from receipts from services such as iTunes. The music, movie and app stores have their own form of currency in the form of iTunes gift cards. No matter the claims the iTunes stores are marginally profitable (a different debate), consider the value of pre-paid iTunes store purchases. iTunes generates cash for eventual disbursement to owners of the products and services sold through the stores, with Apple keeping a goodly percentage of the sales or rental price for its own uses. But consider the interest value of billions of dollars in unredeemed and yet to be redeemed iTunes store balances until used for purchases.

    As interest rates rise, Apple’s return on its cash position will rise proportionally.

    Consider the value of the app store to developers. They have access to a growing pool of pre-paid iTunes card balances, no product packaging or transportation expenses, no product return issues, no transaction fees outside of the agreed distribution fees to Apple and just as importantly the certainty of payment on sales.

    As the developer base for apps grows so will the sales base for apps continue to increase.

    While discussing Apple’s earnings prospects the return on cash isn’t nearly as exciting as discussions about gross margins and product unit sales. But consider the interest value on the nearly $30 billion already on the company’s balance sheet, no debt and the return to an era of rising interest rates as well as growing iTunes gift card sales (and momentarily unredeemed balances) as the uses of the cards extends into mobile device apps.

    I won’t do the calculation here, but consider the quarterly contributions to eps as interest rates rise, the company’s cash balances rise and the velocity of iTunes card sales increases with the proliferation of app store-enabled devices.

         
  • Posted: 13 June 2009 09:16 PM #1

    You could suffer some on unit sales with that scenario of rising rates and tight money. On the other hand with all that cash Apple could be financier of last resort, especially to the school districts.

         
  • Posted: 13 June 2009 09:52 PM #2

    danthemason - 14 June 2009 12:16 AM

    You could suffer some on unit sales with that scenario of rising rates and tight money. On the other hand with all that cash Apple could be financier of last resort, especially to the school districts.

    I believe Apple is already providing financing on attractive terms for large district-wide purchases.

    Rising interest rates will be an indicator of a reviving economy. The iPhone/iPod touch market is growing and growing quickly even in a challenging economic time. The availability of tens of thousands of no-cost/low-cost apps works to the economic benefit of device owners. One investment in an Apple handheld device also pays the admission to a universe of amazing apps that are available at very attractive prices.

    I’m not going to characterize a move to higher rates as a tight money environment, but perhaps a “tighter money environment.” The amount of liquidity in the market today will have a net stimulus effect on the economy for quite sometime and through a period of slow, gradual increases in rates. The Fed can’t keep the money tap open at full forever. The Fed will be forced into a reactive phase of slow and gradual rate increases. It’s inevitable. The only question is when that phase begins.

         
  • Posted: 13 June 2009 10:23 PM #3

    DT, I find your OP and the followup thought provoking.  I am a marketing guy, so take this with a grain of salt, but ...

    The steep yield curve is important to bank profitability.  For the Fed to raise short term rates, they would have to be comfortable that the banks are rebuilt (and comfortable that the economy is recovering.)  This could be a while.

    So I could see maybe, just maybe 50 basis points in the next year.  Are you thinking even more than that?

         
  • Posted: 14 June 2009 12:21 AM #4

    capablanca - 14 June 2009 01:23 AM

    DT, I find your OP and the followup thought provoking.  I am a marketing guy, so take this with a grain of salt, but ...

    The steep yield curve is important to bank profitability.  For the Fed to raise short term rates, they would have to be comfortable that the banks are rebuilt (and comfortable that the economy is recovering.)  This could be a while.

    So I could see maybe, just maybe 50 basis points in the next year.  Are you thinking even more than that?

    A couple of points:

    Bank loan margins are currently at extraordinarily high levels. The spread is huge. Consider the low bank borrowing costs set against 30-year confirming mortgage rates nearing six percent. The issue isn’t performance on new loans, it’s the baggage from the past. As the Feds begin to slowly and gradually raise rates and banks need to compete for source funds, yields will rise.

    Interest rates will rise at a slow and gradual rate. It may be 50 basis points over the next 12 months and perhaps a total of 100 basis points over the next 18 months. Regardless. What’s the percentage increase in yield from today’s rates should interest rates rise by 50 basis points. It’s a huge sum of cash when applied to $30 billion and scales higher as rates continue to rise, even at a gradual pace.

    Further, Apple has its own source financing for R&D and retail store renovation. It’s another competitive advantage when the focus is on hardware and the customer experience.

         
  • Posted: 14 June 2009 12:26 AM #5

    Here’s a chart from the New York Fed.

    As rates eventually rise to near historical norms, Apple will benefit in a material way. Rates will need to rise if albeit slowly and gradually at the start. There’s no way to avoid a rise in rates without an horrific bout of hyperinflation.