Memo To Apple: Carl Icahn Is Right

| About: Apple Inc. (AAPL)

On August 13, 2013, billionaire investor Carl Icahn, 77, took to Web 2.0 platform Twitter (NYSE:TWTR) and tweeted that he held a "large position" in Apple (NASDAQ:AAPL). The tweet heard around the world set off a firestorm of debates pitting hedge fund managers, long-term shareholders, Tim Cook, Apple fan boys, and even Bill Gross, against each other. In the following weeks, analysts had pieced together Securities Exchange Commission filings and Icahn Twitter musings, in order to arrive at the conclusion that Icahn Enterprises L.P. had bought up 3.9 million shares of Apple at an average quarterly price of $464.25. On November 21, 2013, Apple stock closed out the trading session at $521.14 per share.

On October 24, 2013, Carl Icahn went on to launch his Shareholders' Square Table website to help outline his real agenda. Icahn likened corporate governance to a feudalism and fashioned himself as a Robin Hood hero, of sorts. Icahn Enterprises L.P. (NYSE:IEP) then reported that it had controlled 4.7 million shares in Apple stock, or roughly $2.4 billion of the consumer electronics company. This Icahn Enterprises stake amounted to 0.50% ownership of Apple Corporation. Still, Icahn clearly felt entitled and well within his rights to dictate terms to Apple management. In summary, the crux of the debate was to acknowledge that the Apple business model has already matured. As such, Icahn is leading a wing of shareholders that demand Apple be managed as a value play. Apple stock has appreciated by more than 10%, in recent weeks, against this backdrop of shareholder activism.

Dear Tim:

In late October, Icahn published his now widely circulated letter to Apple CEO Tim Cook through the Shareholders' Square Table website. The letter began with an address to the leading man of the world's largest corporation with a casual 'Dear Tim.' Icahn recounted his version of a recent dinner meeting between himself and Tim Cook. Icahn argued that Apple stock was undervalued and proposed an ambitious $150 billion stock buyback program to improve shareholder returns. According to Icahn's back-of-the-envelope calculations, his plan would add an immediate 33% increase in earnings per share, which the billionaire claimed would directly translate into a 33% advance in stock price. Icahn recommended a $525 tender offer from Apple management, to be financed with a combination of cash and debt.

Apple's latest 2013 fiscal year ended on September 28, 2013. Apple closed out its fiscal 2013 with $146.8 billion in cash ($14.3 billion) and securities ($132.5 billion) on the books. In terms of liquidity, Apple's cash reserves and investment positions were more than enough to cover $73.4 billion in accounts payable, accrued expenses, non-current liabilities, and long-term debt on the balance sheet. Apple reported that it had generated $53.7 billion in 2013 cash flow from operations. The company did spend a net $24 billion upon the purchase of marketable securities, after cashing in $124.4 billion upon the maturities and sales of the investments. Apple does maintain the means to execute Icahn's $150 billion share buyback at $525 per share, and leave the company with 650 million shares of common stock outstanding on the balance sheet.

Apple listed tallies of 899.2 million and 939.2 million respective share issued and outstanding as part of its most recently released quarterly report. Earlier this year, in April, Apple sold $17 billion worth of bonds, in order to help finance an ongoing plan to ultimately return $100 billion to shareholders through dividends and buy backs, by the end of calendar year 2015. According to Bloomberg, Apple borrowed 'cheap money' at rates between 1% and 3.85%, which were then 40 and 100 basis points (0.4% to 1.0%) above comparable Treasury securities. This move will help Apple to bypass tax expenses upon the repatriation of more than $100 billion in overseas cash. Icahn, however, has dismissed Apple's current plan as a literal drop in the bucket. Alternatively, bulls railing against Icahn should come to terms with the idea the Apple Revolution has come to a close. Apple may no longer be considered a growth story.

Apple is a Two-Trick Pony

For fiscal 2013, Apple collected $37 billion in net income upon $170.9 billion in total net sales. Of this amount, the Apple iPhone ($91.3 billion in 2013 sales) and iPad ($32 billion in 2013 sales) platforms combined to account for $123.3 billion out of the aforementioned $170.9 billion in sales. In terms of dollar sales, the iPhone and iPad achieved 16% and 3% year-over-year growth above 2012. The iTunes music store, with its $16.1 billion in 2013 sales (25% iTunes year-over-year revenue growth), is arguably the growth driver of Apple. In all, Apple posted 9% year-over-year revenue growth through 2013. By many accounts, the competition is closing the gap in mobile. Taken together, Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC) have averaged $41.8 billion in annual free cash flow from operations over the past five years. It would appear inevitable that these two historic running partners establish Windows as a viable third wheel alternative to the Google (NASDAQ:GOOG) Android - Apple iOS duopoly, at the very least.

On November 5, 2013, research firm comScore released a report that summarized September 2013 U.S. smartphone subscriber market share. Be advised that the title of this release was somewhat misleading, as the comScore report presented averages of data taken from the quarter spanning between July 2013 and September 2013. The comScore information may have confirmed that Apple has already saturated its wing of prospective customers within the smartphone market. Apple closed out this recent summer quarter with a 40.6% share of this market, as both a system operator and original equipment manufacturer. On a sequential, quarter-to-quarter basis, Apple iOS and Apple handsets each gained 0.7% in U.S. market share through the summer months. On a global basis, however, Android and Windows have distanced themselves away from Apple, in terms of unit shipment growth. According to IDC, Android and Windows phone unit shipments increased by more than 70% between calendar Q2 2012 and Q2 2013.

Recent IDC data points have also confirmed that the tablet and smartphone markets have demonstrated similar dynamics. Apple engineers have established the iPad as the market leader. Apple iPad sales growth, however, may have slammed into a brick wall. On October 30, 2013, IDC listed tablet shipments according to Apple, Samsung (OTC:SSNLF), Asus, Lenovo (OTCPK:LNVGY), Acer (OTC:ACEIY), and Other vendors. Apple shipped 14.1 million tablets during Q3 2013, which was a mere 0.6% improvement above the year-over-year period. The Other category, which would include offerings out of Amazon (NASDAQ:AMZN), Microsoft, and Dell (NASDAQ:DELL), grew by 25% to combine for 16.8 million in Q3 2013 shipments. The Amazon Kindle E-Reader begins at $69. Amazon typically retails its hardware at cost, in order to drive Internet traffic towards higher margin product.

The Bottom Line

Carl Icahn may need to revise his back-of-the-envelope estimates. Firstly, Apple closed out the November 21, 2013 trading session at $521.14. Again, Icahn laid out his $525 tender offer proposal back in late October, when Apple was trading near $500 per share. A 5% premium above the current trading price may have Apple offering $550 to buy back shares, in accordance with Icahn's $150 billion plan. At these levels, the immediate and ambitious execution of this buyback may still automatically increase Apple earnings per share statistics by 25%. Apple, and its Standard and Poor's AA+ credit rating, is very much positioned to add a bit more debt to the balance sheet.

Going forward, Icahn and a cadre of Apple bulls may consider actually revising growth expectations downward. Samsung, Google, and even Sony (NYSE:SNE) have already brought wearable computers to market, in the form of separate watches and glasses. With operations man Tim Cook at the helm, the strategic focus has shifted towards the production of the 64-bit A7 chip and the iPhone 5c value play. Steve Jobs' legendary reality distortion field no longer commands Apple. As such, Apple shareholders should no longer expect hyper-growth out of Apple. If anything, Apple will settle into a Microsoft - Intel paradigm, where the business generates heaps of cash, but minimal real growth.

The ongoing catcalls for Apple to return greater percentages of capital back to shareholders have been eerily similar to the developments surrounding the 2004 $3 Microsoft special dividend payout. At the time, Microsoft offered to immediately return $32 billion of its $50 billion in cash on hand back to shareholders. On top of this special dividend, Microsoft also pledged to buy back up to $30 billion worth of outstanding stock over the following four years. Microsoft stock has oscillated between $25 and $35 per share over the course of the past decade. Wall Street traders may begin to play Apple as if it were the next Microsoft.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.