THE GOOGLE CARRY TRADE: The Real Lesson Behind The Company’s New Bond Offering

Google ($GOOG), which is some sort of technology outfit similar to Alta Vista, has decided to go to the bond market to raise $3 billion.

Here’s the odd bit: Google is sitting on $35 billion in cash. However, they can’t use most of that since it’s outside the U.S. (they funnel their money though Ireland). If Google repatriates those dollars, they’ll be hit with a massive tax bill. The company is probably assuming that the corporate tax rate will go down in the future and they’re probably right.

So it’s off to the bond market they go. Naturally, with all that cash, you can be pretty sure that Google is a good credit risk—and the bond market agrees.

The world’s biggest Internet-search company split the sale evenly between three-, five- and 10-year notes, according to data compiled by Bloomberg. The 1.25 per cent, three-year notes yield 33 basis points more than similar-maturity Treasuries, the 2.125 per cent, five-year debt pays a 43 basis-point spread, and the 3.625 per cent, 10-year securities offer 58 basis points above benchmarks, Bloomberg data show.

Even though Google didn’t snag a AAA credit rating, the bond market gave them spreads as if they were AAA.

This is definitely a smart move by Google. Let’s look at Google’s earnings yield (which is the inverse of the P/E Ratio). Based on this year’s earnings estimate, Google’s earnings yield is 6.42%. Based on next year’s, it’s 7.48%. Even going by last year’s earnings, it’s still 5.60%.

In other words, Google’s yield on its equity is far higher than its yield on its debt. The lesson is to use debt. In fact, I think an interesting trade would be to play Google’s risk premium—go long Google’s stock and short the bonds. This is effectively what a company does when it issues bonds to buy back its stock (or in the 1980s when many companies LBO’d themselves).


This post previously appeared at Crossing Wall Street >