Apple Inc. (AAPL) has accumulated an astounding amount of cash, about $100 billion. As Apple can no longer ignore questions about the need for such cash, it was recently announced that Apple is now looking at alternatives for the use of its cash. Many analysts and investors have speculated that the cash use could include possible dividend payments, share buybacks, additional investments in Apple's suppliers, acquisitions, and more.
Apple's cash hoard is larger than most hedge funds out there. What is clear to us is that, in dealing with its cash, Apple needs to act as a hedge fund. In other words, Apple needs to be really smart in how to possibly extract the maximum return from such cash. Given the size of its cash war chest, and Apple's continuous ability to generate additional cash, it is most likely that Apple's strategy will include most suggestions from the previous paragraph.
However, when it comes to acquisitions, in many cases, there is no need for an outright sizable acquisition. The technology industry's success in large scale mergers and acquisitions is often debated. As a consideration, prior to Hewlett Packard's (HPQ) purchase of Compaq in September 2001 in a $25 billion all stock deal, its shares were trading at $23.21 ($20.45* adjusted for dividends and stock splits). As of 2/27/2012, they were trading at $26.25.
From its adjusted $20.45 price prior to the Compaq purchase announcement, although HPQ has gained about 28.4% in about 10.5 years, such return is a meager 2.4% compounded annual rate of return (and that includes all dividends because we used an initial price adjusted for dividends and splits). After 10.5 years, an investment in HPQ had carried tremendous risks, and yet returned less than half of the 4.85% yield at that time for the risk-free 10-year U.S. Treasury note.
Meanwhile, prior to HPQ's 2001 announcement, IBM (IBM), was trading at $99.95 ($87.13* adjusted for dividends and splits), while it closed at $197.53 on 2/27/2012. Hence, although it had not announced a mega acquisition during that time, IBM has appreciated by about 126.7% in the past 10.5 years (from its adjusted price), resulting in an annual compounded rate of return of about 8.1%.
Does that mean Apple should not even consider a large scale technology acquisition? Not at all. It simply means that Apple needs to act as a hedge fund, and be smart about how it structures such a deal. Paying a 20% to 60% premium over market listed prices in order to make a large scale acquisition is simply too risky. However, let's consider the following alternative.
The maker of the Blackberry phone, Research In Motion (RIMM), has seen its shares drop from a record high price of $148.13 on an intraday basis on 7/19/2008, to $14.42 as of 2/27/2012. Its current market capitalization is about $7.44 billion, while it had reached a record market capitalization of over $78 billion in 2008. Meanwhile, RIMM has approximately 75 million subscribers worldwide, with a feature product, the Blackberry phone, with a desirable feature, its instant messaging application: BBM (Blackberry Messenger). Most importantly, the Blackberry has unmatched data security.
RIMM's shares have suffered as it is perceived that consumers will shun its products in favor of the iPhone and Android devices. Could Apple put RIMM out of business? Possibly. However, Apple can possibly gain much more by keeping RIMM in business. This should sound like a familiar dilemma to Microsoft (MSFT) and Apple.
In 1997, it seemed that Apple itself was in danger of going out of business (see our article of August 15, 2011, "Who will take a bite out of Apple? Anyone") as its software competitor, Microsoft, had almost cornered the operating system market. What kept Apple alive? Microsoft, that same competitor that almost drove Apple out of business. Bill Gates invested $150 million in Apple, in the form of preferred stock that was ultimately converted into a total of about 18.2 million Apple shares in 2000 and 2001 (according to Apple's 2003 10K filing).
The Microsoft-Apple deal in 1997 was a win-win deal for both. Apple received the cash it needed to stay in business (and ultimately became the world's largest company with a market capitalization in excess of $490 billion). Microsoft was able to secure the bundling of its products into the Mac operating system. Had Microsoft retained such shares, taking into consideration Apple's 2005 2-1 stock split, they would be worth $19.6 billion as of 2/27/2012 where Apple closed at $526.76 (a 12,800% gain), a much better investment than had Microsoft bought its own shares at that time. Most importantly, as stated by Tony Perkins of The Red Herring, Gates bought himself antitrust insurance policy. It is time Tim Cook of Apple also starts thinking about that.
A possible move by Apple on RIMM would have to resemble the 1997 Apple-Microsoft deal, as opposed to an outright purchase. Assume Apple enters into a deal to have the right to invest $3 billion in RIMM, during the next five years, to purchase RIMM shares at a 20% premium from current levels, or a strike price of $17.3, in return to bundle RIMM's Blackberry subscription services into Apple devices such as the iPhone and iPad, along with other strategic collaborations.
Such a deal will put to rest any doubts about RIMM's future. It is very likely that such a deal would possibly immediately cause RIMM's share to move from their current estimated PE ratio of about 5 (using analysts' net earning estimates of $2.89 for the period ending Feb 2013), to a PE ratio of 10. Hence, providing an increase in market capitalization to about $15 billion. In addition, assuming such lifeline causes RIMM to beat current estimates by 20%, RIMM's market capitalization could reach $18 billion.
In the case of the iPhone alone, there has been in excess of 160 million iPhones sold since its debut. In the last quarter alone, Apple sold 37 million iPhones. According to the International Communication Union, the global market for active mobile broadband subscriptions is estimated at a staggering 1.186 billion, with a penetration rate of about 17%.
Given such figures, it is reasonable and conservative to estimate that such a deal between AAPL and RIMM could generate a minimum additional 15 million Blackberry subscriptions on a net basis (after taking possible cannibalization into consideration). Assuming a conservative net revenue of $3 per month from each subscription, that would yield net additional annual revenue of about $540 million. Again, using a PE ratio of 10, that would add an additional $5.4 billion in market capitalization to RIMM to reach about $23.4 billion, which is $16 billion higher than its current market capitalization.
Assuming Apple exercises its option, an additional $3 billion would be pumped into RIMM, which could raise its market capitalization to $26.4 billion. Assuming total dilution for the issued shares to Apple, that would possibly lead to a share price of about $38.2. Such a number could ultimately be substantially higher, as we used a rather conservative estimate of net Blackberry subscription additions, as well as conservative net revenue figure per subscriber. In addition, we have not taken into consideration other benefits from strategic collaboration between Apple and Research In Motion.
The above scenario is hypothetical, but if it was to occur, Apple's $3 billion investment could possibly become worth $6.6 billion, yielding a net profit of about $3.6 billion (120% gain). Apple would also hedge its antitrust legal risk by keeping the Blackberry alive. Meanwhile, RIMM would also improve its chances for staying in business, while its share price can possibly appreciate as demonstrated, and possibly more.
Is this a good business proposal or would such hypothetical engagement between Apple and Blackberry merely create product confusion, cannibalization, and basically, a fruit salad?
If history is a lesson, at its announcement, the 1997 Apple-Microsoft deal also had its skeptics ... Yet, both companies are still around, and they have both benefited from the deal. Most importantly, consumers have also benefited from product diversification and competitive innovation.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL, RIMM over the next 72 hours.
