2013 was hailed as the year of the share buyback. But corporate share repurchases don’t seem to be slowing down this year either. Wednesday after the close Apple (NASDAQ:AAPL) announced in its quarterly earnings report that it would be increasing its share buyback plan from $60 billion to $90 billion and do a 7 for 1 stock split. Share buybacks can be a good way for companies to give value to investors. For the uninitiated, a share buyback in theory is not much different than a special dividend, but it can have better tax implications. The company uses cash from its balance sheet to repurchase a small percentage of shares from investors, both transferring cash from the company to shareholders and generally increasing the value of the company stock because there are fewer shares outstanding. It’s a supply and demand play, a way for the company to express confidence in its own future, and an easy way to make key financial metrics look better. Both earnings per share (EPS) and price to earnings (PE) ratios look better without earnings actually increasing, because it leaves fewer shares outstanding.
But not all investors agree that share repurchases are always a good idea. Let’s take a look at how share buybacks work in practice and what Apple has been quietly doing with its war chest of cash behind the scenes.
Let’s start by talking about one of the biggest share buyback cheerleaders of all time, legendary activist investor and hedge fund manager Carl Icahn. Icahn is notorious for buying up shares of companies and then getting very loud about changes he wants to see, which he believes will increase his value as a shareholder. His ruthless tactics have some even calling him a pirate. Apple ended the quarter with nearly $151 billion in cash on its books, probably way more money than they have any idea what to do with. Since announcing his stake in Apple back in August 2013 Carl Icahn has been reiterating that Apple stock is undervalued and has demanded that Apple reduce its cash position by buying back shares. Here’s what he had to say on Twitter about the $30 billion increase in share repurchases announced on Wednesday.
But not all investors necessarily agree with activist investors though, and they can be a nightmare for company management who often face conflicting incentives in their presence. When interviewed on Wednesday about activist investors on CNBC Warren Buffett said, “The CEOs are terrified of activists [investors], I can tell you that. They’re all talking to investment bankers and lawyers and saying what do we do about all of this.” Buffett went on to say that not all activist investors can be lumped together and generalized as either good or bad for corporations, but if they buy up huge chunks of equity it is hard to argue against their right to ask for changes.
There are a few decent arguments against repurchase plans. The first has to do with the fact that share buybacks essentially insist that the company make a valuation judgement about its own stock price, something way outside the core competencies of a tech company like Apple. Another common complaint has to do with determining what is the best possible use of cash to spark future profits. If you’re a long time term investor in Apple, a share buyback may look attractive and offer short term gains, but there could be better options out there too. Maybe it’s better to leave the question of share valuation to the market, investors will tell you if your stock is undervalued or not by either buying or selling the shares, they have a clear incentive to. That’s why serious long term investors can be frustrated by Icahn. He can barge in, demand a shareback, and then walk away with millions of dollars in profits while arguably hurting the welfare of the long time horizon investor by limiting the company’s optionality which cash provides.
Aside from repurchasing shares or doing special dividends, the other way that a company can leverage a pile of cash is through merger and acquisition activity. Buying up companies with natural synergies is a powerful long term play. It may not immediately boost the financial metrics and share price like a share repurchase can for a massive company like Apple, but it could have more robust long term benefits.
Apple is a notoriously sneaky company, but that doesn’t mean they’ve been quiet in M&A activity. Take a guess how many companies Apple has acquired in the past year and a half. According to CEO Tim Cook the answer is 24. Apple has quietly been putting pieces in place to strengthen its future and potentially aid in the development of new products. Apple keeps its mouth shut about whatever its working on it until the product is ready to hit the shelves, they are also extremely discreet in the way they conduct mergers and acquisitions. They don’t always hold fanfare, parades, and fireworks when they make a deal like Facebook (NASDAQ:FB) does, but that doesn’t mean they aren’t making moves. Apple’s acquisition spree over the past 18 months has even outpaced Google (NASDAQ:GOOG) (NASDAQ:GOOGL), go figure.
While valuing shares may not be Apple’s strong suit, innovation certainly is. The $30 billion share repurchase and 7 for 1 stock split may be grabbing headlines, but don’t let the misdirection fool you. Apple is spending just as much cash as it believes makes sense on internal research and development and M&A activity. And innovation and product development is what Apple does best. The good people at Wikipedia have given us a partial list of Apple’s recent deals, but a few may have slipped through the cracks and gone under the radar.
Who do you think Apple might have acquired? What would you do if you were Tim Cook and had $151 billion to spend? To put things in perspective, even buying Tesla (NASDAQ:TSLA) isn’t outside the realm of possibility. Even with its high stock price that many claim to be a bubble, Tesla still only has a $25 billion market cap, chump change for Apple. Head over to our M&A prediction platform and submit your guess. Predictions for future M&A activity for Apple already range from Yelp (NYSE:YELP) to Square to Pandora (NYSE:P), and even include the possibility of buying PayPal from eBay (NASDAQ:EBAY). Who knows what Apple might do in the future, or what they’ve already done. Apple loves to keep their cards close to their chest, but the next couple years under Tim Cook should be exciting to watch.