Whilst the weight of such a huge buyback will almost certainly boost the stock in the short term, how will it impact longer term investors?
The idea behind a buyback is simple. If a company believes its stock price is undervalued it can buy its shares in the open market thereby investing in itself. If the company's share price subsequently rises it creates shareholder value. If the stock price falls it destroys value.
A company should only be investing in itself if it genuinely believes it is undervalued and the underlying business is solid. Warren Buffett will only re-buy stock in Berkshire if he believes it is cheap, which for him usually means it is close to trading at or below book value.
Unfortunately many companies blindly buy back stock regardless of price and often buy more stock when the price is high than when it is low.
Apple's Current BuyBack
Back in April Apple announced a $60 billion buyback program to add to the $10 billion program announced in 2012. In Q3 Apple repurchased and cancelled just under 34 million shares reducing outstanding shares by 3.6% in a single quarter.
The exact repurchase price is currently unclear but we know Apple bought just under 9 million shares in the open market at an average price of $446.74.
The total number of shares ultimately delivered, and therefore the average price paid per share, will be determined at the end of the applicable purchase period based on the volume weighted average price of the Company's stock during that period.
|No. Shares Purchased||Average Price per Share|
|August 2012 ASR||1,494,922||-|
|April 2013 ASR||23,507,518||-|
|Open Market Purchases||8,953,712||$446.74|
If we estimate that all 34 million shares were bought at an average of $450 today's price of $490 would imply Apple has created $1.36bn in shareholder value today although it remains to be seen how this will change over the longer term.
Apple's huge cash pile of $146bn is earning just 1.00% in US treasury bonds. Below the rate of inflation and well below an investors required rate of return. The cash is destroying shareholder value. Even if Apple doesn't use this cash to buy back its own stock it should be using it for something else.
Is there an Argument for a Rainy Day Fund?
Maybe. I'd be interested to see what people have to say on this. Theoretically the answer is probably no. In practice we have seen just how dangerous tech is. Unfortunately Apple derives a huge amount of its earnings and profits from just a few products and these must be continually updated. A single bad product update could have a devastating impact on sales and earnings. You might argue that tech businesses should have a cushion so they have time to catch up and make up for past mistakes if they need to.
However regardless of this potential danger Apples current cash pile is undoubtedly excessive. Earlier in April when the stock traded as low as $380 almost 40% of the company's market cap was in cash.
The current plan to return $100 billion by the end of 2015 should barely make a dent in the current $146bn if Apple continues to add cash at the current rate.
If Apple continues to make net income of $40 billion a year (and Apple will probably add cash faster than net income) net cash should go almost nowhere (2.25 years x $40bn = $90bn). $146bn - $100bn + $90bn = $136bn.
Apple should be using more of its cash. Because Apple dislikes making large acquisitions it has only two choices. Either buy backs its own stock or return cash to shareholders in the form of a special dividend.
Unfortunately much of Apples cash is locked away overseas. In order to buy back stock Apple will have to issue debt in the US as it did in May. The interest on this debt is an added expense that Apple must pay. Should this expense stop Apple buying back stock?
What interest effect has the current buyback had?
Based on the Q3 numbers by my calculation Apple will pay roughly $329 million annually in interest on $17 billion of long term debt. Assuming a tax rate of 27% Apple will save $89 million in tax annually on the interest expense.
|Amount ($m)||Effective Rate||Annual Cost ($m)|
|Floating Rate due 2016||1,000||0.51%||5|
|Floating Rates due 2018||2,000||1.10%||22|
|Fixed Rate 0.45% due 2016||1,500||0.51%||8|
|Fixed Rate 1.00% due 2018||4,000||1.08%||43|
|Fixed Rate 2.4% notes due 2023||5,500||2.44%||134|
|Fixed Rate 3.85% due 2043||3,000||3.91%||117|
Given the exceptionally low cost of borrowing, any interest expense would currently be almost immaterial to Apples earnings. This interest cost is not an argument against a buyback and should in fact encourage Apple to act more quickly with the danger that rates will continue to rise. Apple will also save $415 million ($12.2 *34m) in annual dividend payments on the shares that it cancelled in Q3 alone. So by my calculation Apple is already saving $175 million a year from the buyback with more share repurchases to come.
Apple's stock is now more expensive than in April. This should make any decision to buy back stock tougher for Apple's management. However the stock is still very cheap with a P/E of less than 8 ex cash. Apple also has potential upcoming catalysts such as a China Mobile deal.
AAPL data by YCharts
The Product Cycle
Apples revenue growth has always moved in cycles. If we look back we can see how volatile Apples share price is and how tied the stock is to the launch of new products.
Apple Revenue Annual Growth
|FY 2007||FY 2008||FY 2009||FY 2010||FY 2011||FY 2012E||FY 2013E|
Following the release of the iPhone in 2007 revenue growth leapt 52.5%in 2008 but fell back to just 14.4% in 2009. When the iPad was released in 2010, revenue growth re-accelerated to 52% and then 66% in 2011. In 2012 and 2013 there were no new product category launches, revenue growth slipped back to 44.6% and a predicted 8.7% in 2013.
It has been a very quiet 2013 for Apple so far until the recent launch of the new iPhones. In my opinion Apple is moving off a cyclical low point in its product cycle. The double iPhone launch, new iPads and iWatch are likely to re-accelerate revenue growth in 2014. If this is the case it would be an ideal time to start a major buyback.
Apples management has true visibility on Apples product cycle and therefore they are by far the best judges to how Apple will do in the future and should act accordingly.
Icahn is right to say that Apple is not allocating its capital efficiently. Apples cheap valuation, the success of the new iPhones, an impending China mobile deal, low interest rates and new product categories 2014 all suggest Apple should be buying back more stock.
However the decision should ultimately rest with Apples management who have by far the best visibility on Apples future. If management believes the business will struggle in the future it should still be returning some of Apple's excessive cash to shareholders in the form of a special dividend.
Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.