The market is developing a more and more voracious appetite for yield vehicles and continues to be tepid for equities. In the spirit of always giving the market what it wants, one solution is to convert equities into yield vehicles with financial engineering. To show how this can and will be done, I am analyzing the potential for leveraging Apple(AAPL) - not because I believe that what I describe will actually happen but because I think it provides an example of what will likely happen over and over again as long as the gap between interest rates and earnings yields on stocks continues to be so large. I am also asking readers to give me a little bit of poetic license so that I can ignore transactional costs and tax issues in order to look at the big picture.
AAPL throws off an immense amount of cash (roughly $30 billion a year), and that cash flow can be harnessed to produce reliable yield. In addition, AAPL has some $82 billion of idle cash on its balance sheet(as of the end of the last quarter - undoubtedly more as we speak). My restructuring would be simple. A new entity, Apple Financial, would be formed as an open end mutual fund and spun off to AAPL shareholders. It would have a value of some $87 per share. It would continue to invest conservatively in fixed income debt instruments and might evolve in the direction of a Pimco Total Return Fund model.
As a second step, each shareholder of AAPL would receive two $25 bonds with a duration of 5 years and a yield of 2%. Given AAPL's financial strength, these bonds would likely get a AAA rating and trade at par. IBM has bonds with a similar duration and coupon which trade near par. As a result of this AAPL, would now have some $47 billion of debt - not overly burdensome given its $30 billion a year of cash flow after CAPEX.
The new AAPL (which we might nickname the "Core") would have lower earnings but not by much. Roughly $1 billion a year of pre tax earnings on the cash hoard would be gone and there would be a $900 million interest expense. But the after tax impact would probably be a roughly $1.2 billion a year hit to earnings. This would leave us with a current year's earnings projection of $33.64 per share.
The shareholders would have $137 of assets spun off to them and so any share price over $284 would be "finding money in the street." $284 is roughly 8.5 times this year's consensus earnings and AAPL almost always beats the consensus. Even at ten times this year's earnings (which seems conservative for a growth stock like AAPL) AAPL would be priced at $336 - a nice $52 pop for shareholders.
I don't think that AAPL will move in this direction - it would be a very "un-Apple" kind of thing to do. But I think that these numbers illustrate what must be going through a number of financial executives' minds right now - if investors are in love with bonds and are willing to accept ultra low yields, we sure don't want to disappoint them.