Many investors and commentators, both here on Seeking Alpha and the broader investment community, have spoken of Apple's (AAPL) enormous cash hoard and the need for the company to do something with the cash it has. As of the end of the 2011 fiscal year on September 24, Apple had $81.57 billion in cash and marketable securities on the balance sheet, and no debt. We breakdown Apple's cash below.
|Asset (in Billions)||Q4 2011||Q3 2011||Q2 2011||Q1 2011||Q4 2010|
|Short-Term Marketable Securities||$16.137||$16.304||$13.256||$16.243||$14.359|
|Long-Term Marketable Securities||$55.618||$47.761||$36.533||$32.730||$25.391|
|Q/Q Change (%)||7.109%||15.797%||10.150%||17.047%||N/A|
With cash soaring, many have been clamoring for the company to release its cash either in the form of a major acquisition, dividend or stock buyback. Though all three are tempting, prudent investors will see the folly of these. We delve into the reasons why below and highlight the most important use of Apple's cash.
1. Acquisitions: With the largest cash balance in the tech industry, not a day passes when some company is described as an acquisition target. As holders of several companies thought to be in Apple's crosshairs, including Akamai (AKAM), it is tempting to want Apple to reduce its cash balance through acquisitions. But there is a flaw in this plan. Apple eschews large acquisitions, (the largest was the $404 million purchase of NeXT), preferring instead to buy smaller companies that can be easily integrated into existing product lines and divisions. Furthermore, if the end goal is to reduce Apple's cash balance, the company would need to buy multi-billion companies every quarter just to negate its enormous cash flows, to say nothing of actually reducing its current cash balance. Such a string of acquisitions, or an enormous one, could potentially distract Apple's management from its continuous innovation. Competition is brutal, and Apple needs all the focus it can to outwit its competitors. A substantial acquisition could cause the company to lose focus and suffer in the long run.
2. Share buybacks and dividends: Unlike many large tech companies, including Intel (INTC), Cisco (CSCO) and Microsoft (MSFT), Apple returns no cash to shareholders directly, though if you ask Apple investors, they would tell you they are far happier with the returns from Apple's stock appreciation than any of the dividends they've received from those three companies. That being said, arguments can in fact be made for a buyback or dividend. Apple has no debt. Does it really need over $81 billion to run the company effectively and retain a cushion for potential tough times? Some say no.
But we see many flaws with calls for a dividend or buyback. For starters, as CFO Peter Oppenheimer pointed out on the last conference call, over $54 billion, or two-thirds of Apple's cash, is offshore, and cannot be repatriated to the U.S. for dividends and buybacks without paying steep 35% tax rates. Given that calls far another tax holiday have fallen on deaf ears, we do not think another tax holiday is in the cards. But perhaps more importantly, a dividend or buyback would be seen by many investors as a sign of weakness. Cisco, Microsoft and Intel use dividends and buybacks to boost their stock prices, since their growth is not enough to push the stock higher. They are in effect, subsidizing the stock, but with little success.
Over the past five years, Apple stock has risen by over 327.48%, while Cisco and Microsoft have fallen 35.14% and 17.78%, respectively, despite spending billions on dividends buying back stock. Intel has managed to rise 5.13% over that time period, but the increase in its market capitalization is nowhere near the billions it has spent on dividends and buybacks. Should Apple initiate a dividend or buyback, many current shareholders will see it as a sign that management thinks that growth alone is no longer rapid enough to raise the share price. Even though many investors would cheer returns of capital, just as many would sell due to fears over growth.
Sentiment is often more powerful than fundamentals, and the sentiment surrounding returns of capital could prove to be negative. On the call, CEO Tim Cook commented that, "On your (Merrill Lynch analyst Scott Craig) cash question, to date as you know, we've wanted to maintain flexibility. I think everyone that knows us knows that the cash isn't burning a hole in our pocket and we're not the type of people to do silly things with it. We invest it conservatively. If you look at Gary (Treasurer Gary Wipfler) and his team's track record, they've done a phenomenal job in a extremely difficult market for the last few years. We've also taken money and done things with it that are in Apple's best interest. For example, we've acquired several companies. We've acquired some IP as you know. We've invested in the supply chain, and we used money to build out our stores and provide for a lot of new product tooling and the like. And so I believe what we're doing with cash, the way we're - this cash that we do spend we're doing an extremely good job of it and we're very frugal about using it and using it in the right places. That said, I'm not religious about holding cash or not holding it. I'm religious about a lot of things but not that one. And so we will continually ask ourselves what's in Apple's best interest and always do what we believe is in Apple's best interest. And so it's a topic for the board on an ongoing basis, and we'll continue to discuss it."
Tim Cook is more benign on cash than Steve Jobs, and while we will have to wait for how he uses cash, we continue to believe that for now, a dividend and buyback are not the best use of Apple's cash. While Tim Cook does not see buybacks as being a sign that Apple can no longer innovate, many investors would, and we think that now is not the proper time to return cash to shareholders this way.
So what does Apple do with its cash? Surely the company does not simply let it sit there, collecting a small (relatively) amount of interest? Of course not. The company invests it in ways that are far more important that acquisitions, dividends or buybacks.
There is a reason Apple's products always seem more than just beautiful pieces of craftsmanship. They seem downright magical, as if they appeared out of thin air. But it is not magic that allows for this effect. It is science. And billions in investments. Apple's cash hoard is larger than the entire market capitalizations of nearly all of its competitors combined, including Research In Motion (RIMM), HTC, Motorola Mobility (MMI) and Nokia (NOK). As such, the company can sign contracts with suppliers that its competitors simply cannot afford to match. Apple is brutal in its negotiations with suppliers, but the efforts are rewarding, both to Apple and its suppliers.
It is common practice for Apple to subsidize the building of factories or the development of new materials and equipment to build its products. In exchange, the company demands exclusive use of those materials and equipment, meaning that only Apple has access to the newest technologies for months, sometimes even years. This is why the company's devices are so advanced. None of its competitors have access to the proper materials. And we are almost certain that as soon as the full ramifications of the Thai floods were realized, Apple began stockpiling hard drives, locking out its competitors in the process. We are certain that should there be a shortage of computers on store shelves this holiday season, Apple will not be affected.
Apple leverages its unmatched balance sheet to lock out the competition, spending billions to outbid competitors for crucial contracts, materials and equipment. It is a virtuous cycle where these innovations lead to more cash on hand and an even tighter grip on its supply chain. Apple has not gotten to where it is today on the back of mere magical products. It has taken its place as the largest technology company by ruthlessly executing its product roadmap, using an industry leading supply chain to do so. Its supply chain is only possible with billions in cash, and for now, we think that is where Apple's cash should go. There may be a time in the future where Apple will pay a dividend and buy back stock, or buy companies, but that time is not now.