Why do companies offer bonds to investors and what does it mean for traders?
Apple Inc (NASDAQ:AAPL) and Royal Dutch Shell Plc (LON:RDSA) are jumping on the bandwagon by raising bonds in Europe. Apple bonds will have eight and 12-year maturities with returns of 1% and 1.6% respectively. So what does it mean when a company issues bonds, and what should you look out for as a trader?
In much the same way as banks offer loans to clients in order to collect interest repayments on borrowed money, corporations borrow money from investors to try and finance their own operations. With interest rates at historically low levels, the cost of borrowing money is now cheaper than at any point in recent history.
Instead of approaching banks and financial institutions for money, companies can approach shareholders and investors to buy into the company by way of bonds.
This is different to purchasing shares in a company. Share prices, yields and returns with any company listed on the stock exchange are never guaranteed. With a bond, the company issuing the bond for a pre-stated period of time at a fixed interest rate is obligated to repay the investor at expiry time. Companies offer these types of bonds to raise capital to repurchase their own stock, among other reasons.
Apple to issue two sets of €500m eurozone bonds
Barely 24 hours after Apple released its brand-new iPhone 6S and iPhone 6S Plus, the announcement was made that €500 million worth of eight-year bonds and €500 million worth of 12-year bonds will be issued in Europe. Apple will be using the proceeds to repurchase Apple stock from investors. This is seen as a positive move for eurozone bond markets, after a precipitous decline following the Chinese equity collapse in August.
It should also be remembered that this is not the first time that Apple Inc has issued bonds in the global market – it did so this year in Australia with the sale of ‘kangaroo bonds’ worth A$1.6 billion.
Almost a year ago, Apple issued €2.8 billion worth of bonds in Europe, making it the first time that non-dollar-denominated bonds were raised with eight and 12-year maturities. The rate of return that Apple is paying on eight-year bonds is 1% and the rate of return for 12-year bonds is 1.6%. The sale of bonds is nothing to be alarmed about, since many American companies have started issuing euro-denominated bonds recently.
In fact, American corporations have been able to raise more euro-bonds than European companies have in the same timeframe. As at 7 September 2015, corporate entities (with the exclusion of banks and financial corporations) raised a total of €53.9 billion. It’s not only Apple Inc that has been raising bonds in this way: Royal Dutch Shell has also entered the market with the issuance of euro-denominated bonds. Apple Inc intends to use the funds generated from the sale of bonds to pay dividends to shareholders in addition to share buybacks.
Borrowing from investors makes sense for Apple
Over the past two years, Apple has raised over $55 billion by way of bond issuances globally. The 12-year bonds are issued 85 points higher than benchmark interest rates. The company is looking to pay back $200 billion to investors within the next one-and-a-half years (March 2017) as it continues its aggressive policy of retail expansion around the world.
Bank of America Merrill Lynch indices indicate that US-based companies are able to generate capital in euros at a 2.07% discount compared to borrowing costs in USD. For companies like Apple Inc, it makes financial sense to borrow from investors, because the costs are so much lower and they retain investor interest in the company. At that rate of interest (under 2% for 12 years’ worth of capital), Apple Inc is clearly getting a good deal.
When companies like Apple Inc and Royal Dutch Shell plc issue bonds, they are mindful of how many basis points above prevailing rates they are paying. For investors, there is the added security of a fixed interest rate of return which is between 30 and 60 basis points higher than the respective returns in the financial markets for eight-year investments and 12-year investments respectively. It is a safer way to generate fixed returns for those with the funds to invest in euro-denominated bonds.
Where is the money going to go?
Apple Inc will be using the money generated from the sale of bonds for dividend payments, funding capital expenditure, debt repayments, acquisitions, share buybacks and the like. Apple has many plans in the pipeline including many new iPhone products and accessories, game-playing devices and accessories, and other customised technological innovations.
Much the same is true for Royal Dutch Shell, which recently issued €3.45 billion in bonds on Thursday 10 September 2015. Unlike Apple however, Shell’s bonds have maturity dates of four years, six-and-a-half years and 10 years.
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