include in it, and the answer is that it should comprise not just the interest-bearing liabilities that you see on a company’s balance sheet, but also other contractual commitments that the firm faces. Lease commitments, for instance, should be considered as debt and brought into your debt number, making a significant difference in the debt value at retail firms and restaurants, which have substantial operating leases. With cash, you have two details that need to be ironed out. The first is a phenomenon specific to the United States, and largely the result of the US corporate tax law. The US tax code requires US-based companies to pay the US corporate tax rate on their foreign income, but only when that income is repatriated to the US. US companies, not surprisingly, choose not to bring their cash back to the United States, thus trapping that cash in foreign locales. In late 2015, about $120 billion of Apple’s $200 billion cash balance was trapped in its foreign operations and bringing that cash back to the US would result in a tax bill of close to $20 billion. When valuing Apple, you have to decide whether you, as equity investors in the company, will ever face this tax bite, and if so, when. The second is in markets where cash balances can be invested in risky securities, where the book value (reported in the financial statements) may be very different from the current value. Cross Holdings: It is not uncommon for a company to hold portions of other companies and as an investor, you partake in these holdings. As a consequence, you have to bring in the value of these holdings into your estimated value and to do this, you first have to understand how the firm accounts for these holdings. With both US and international accounting standards, holdings can broadly be classified into majority holdings, where you own a controlling stake, usually (but not always) more than 50%, of another business, or minority holdings, where you hold a smaller stake in another business. With you are required to consolidate your majority holdings, financial statements, act as if you fully own the subsidiary, and report operating
include in it, and the answer is that it should comprise not just the interest-bearing liabilities that you see on a company’s balance sheet, but also other contractual commitments that the firm faces. Lease commitments, for instance, should be considered as debt and brought into your debt number, making a significant difference in the debt value at retail firms and restaurants, which have substantial operating leases. With cash, you have two details that need to be ironed out. The first is a phenomenon specific to the United States, and largely the result of the US corporate tax law. The US tax code requires US-based companies to pay the US corporate tax rate on their foreign income, but only when that income is repatriated to the US. US companies, not surprisingly, choose not to bring their cash back to the United States, thus trapping that cash in foreign locales. In late 2015, about $120 billion of Apple’s $200 billion cash balance was trapped in its foreign operations and bringing that cash back to the US would result in a tax bill of close to $20 billion. When valuing Apple, you have to decide whether you, as equity investors in the company, will ever face this tax bite, and if so, when. The second is in markets where cash balances can be invested in risky securities, where the book value (reported in the financial statements) may be very different from the current value. Cross Holdings: It is not uncommon for a company to hold portions of other companies and as an investor, you partake in these holdings. As a consequence, you have to bring in the value of these holdings into your estimated value and to do this, you first have to understand how the firm accounts for these holdings. With both US and international accounting standards, holdings can broadly be classified into majority holdings, where you own a controlling stake, usually (but not always) more than 50%, of another business, or minority holdings, where you hold a smaller stake in another business. With majority holdings, you are required to consolidate your financial statements, act as if you fully own the subsidiary, and report operating
NarrativeMay2016.docx