Apple (AAPL) finally decided it was time to return some of its massive cash balances to its shareholders. The Cupertino based company, which held $98 billion in cash at the end of 2011, will initiate a $2.65 quarterly dividend starting in its fiscal fourth quarter. Furthermore, it will buy back up to $10 billion in stock over the coming three years to offset dilution of incentive plans.
The dividend announcement
The quarterly dividend of $2.65 will be the first dividend paid since December 1995, and will cost the company around $2.5 billion per quarter. CFO Peter Oppenheimer argues that the dividend, in combination with the repurchase program, is the best solution after he listened carefully to its shareholders in order to get "the right input."
Former CEO Steve Jobs disliked the idea of dividends after the company almost ran out of cash in 1996. Furthermore, Jobs did not like to have meetings with shareholders altogether, as he preferred to focus on the operational and innovative side of the business.
Cook disagrees with Jobs and tries to cater more investors by initiating the quarterly dividend, which at $10 billion per year is the second largest in US corporate history. The annual yield of 1.8% is equivalent to the dividend yield on the S&P 500, which runs at around 2%
The $10 billion buyback program will take up to three years. It is not designed to actually decrease the number of shares outstanding in an effort to increase earnings per share. Rather it tries to offset dilution coming from employee stock ownership programs and options grants in an attempt to limit the increase in outstanding shares in the future.
Steve Jobs actually liked the idea of a buyback much better than dividends, as they are not "sticky" (investors are not expecting a buyback every year). After the 9/11 attacks in 2001, Jobs actually seriously considered a buyback but decided the cash was better spent investing in the company's future. He talked about a buyback in subsequent years with Warren Buffett on multiple occasions; Buffett advised Jobs to initiate a buyback if he thought the company was undervalued.
Modest cash distribution
Over the next three years Apple will spend about $45 billion in dividend and share repurchases according to its CFO. This is rather limited if we compare this to its staggering $98 billion war chest. Like many US companies, Apple holds a lot of cash in foreign countries, and bringing it back to the US makes it subject to the repatriation tax. It is reported to hold a mere $34 billion in the US, which will be used to pay dividends.
Despite a limited cash balance in the US, Apple could initiate a much more generous distribution plan. In 2011 the operational cash flows came in around $45 billion, and the company invested a "mere" $5 billion back into the business. At the $15 billion annual rate of cash distributions to its shareholders, this means that the cash balances of the company will continue to grow, and the debate about how to use it will continue in the future.
Catering to shareholders
By initiating a dividend, Apple is able to cater to its last segment in shareholder clientele which it did not serve until this point in time. The dividend announcement will make Apple an eligible investment for many mutual funds which are restricted to dividend-paying companies. This means that the whole investment community, including retirees' 401Ks, hedge funds, dividend mutual funds and ETF investors, is massively long Apple. In this environment it becomes difficult to find marginal buyers to push the stock up even more. The stock has rallied a lot over the last trading week, in anticipation of a cash distribution. The announcement shows that CEO Cook is clearly in charge and he is not trying to replicate Steve Jobs.
What is going to drive shares higher?
Monday's press conference was a good news show. Besides the announcement of the dividend and the repurchase program, Apple also announced that a record 3 million new iPads were sold over the weekend.
The recent moves upwards toward the $600 level intensify the debate between the bulls and bears. With operational excellence, growth and a shareholder friendly strategy already in place, what's left to drive the price up further?
In the second part of this article I would like to point out some general and specific points which could possibly hint that Apple is in a bubble:
1. The share price is almost moving parabolic.
After years of steadily increasing, Apple's shares have returned 44% year to date. Consequently the price-earnings ratio is actually increasing as the stock goes up faster than its profits. Apple is becoming such a large company that the law of large numbers will increasingly become more applicable. Growth will eventually come down as the company becomes a larger part of the economy and in particular takes up a larger percentage of consumer discretionary spending.
2. Stock and option volumes are peaking
It is not just interest in Apple's products which is continuously on the rise, so is trading in its stock and options.
Share volume peaked at 50 million shares earlier this week, or roughly 5% of shares outstanding. This indicates that the average investor holds the shares for just 20 trading days. This compares to just 0.3% turnover for Exxon Mobil (XOM), the second largest company as measured by market capitalization, indicating that its investors, on average, hold the shares over a year. Furthermore, option volume in the stock has surpassed the 1 million contracts a day. This is not because of hedging purposes but outright speculation by financial participants on continuous gains or a reversal in the trend.
3. Largest corporation in terms of market capitalization
With a market capitalization of around $550 billion, Apple has the largest market capitalization of any publicly traded corporation worldwide. History shows that maintaining such a leadership position on the well-known Forbes list is a hard thing to do. An obvious example is, of course, tech giant and competitor Microsoft (MSFT), which led the list around the turn of the century. 12 years later its shares trade 40% below the peak of 2000.
4. Financial news networks go crazy
Financial networks such as CNBC talk about Apple as if it is a new market indicator. Statement including "the market is ticking down because Apple is down" are common phrases in today's broadcasts. Special shows discussing the timing of when the stock would surpass the $600 level fuel the rally. Besides interest rates, exchange rates and oil prices we now have a new market indicator: Apple stock.
5. Analysts go crazy
Morgan Stanley (MS) raised its price target for Apple to $720 while it simultaneously raised its earnings estimate. In Morgan Stanley's "bull case," shares could hit $960 as the company would be on track to earn $80 per share in 2013 as it rolls out products to more markets. The investment bank expects Apple to generate an incredible $270 billion in revenue for 2013, which compares to $108.2 billion the company reported in 2011. Morgan Stanley's price target implies a valuation close to $1 trillion. Competitor Deutsche Bank (DB) thinks the latest rise is a good moment to take profits, and it removed Apple from its short term buy list.
6. The hedge fund community
Roughly 30% of all hedge funds are reported to be long Apple, with many of them adding to their positions in the final quarter of 2011 and the beginning of 2012. If short term oriented hedge funds have already massively bought into the stock, who is the next marginal buyer driving the stock higher?
7. Innovation is slowing down
The loss of Steve Jobs inevitably slows innovation down, despite all the efforts to maintain the culture under his leadership. Employees are already reporting that decision making takes much longer and the number of corporate meetings is on the rise. Apparently the decision making process already takes 15 days longer compared to the days when Jobs was in charge. With most current innovations already being in the pipeline under Jobs' command, the actual slowdown in innovations and product development may not be seen until 2013.
8. The Chinese problem
The prominent New York Times recently shed its light on poor working conditions at Apple's main subcontractor Foxconn in a large weekend article. Problems include unsafe working conditions, explosions at facilities, high suicide rates and continuous violation of working hours. Foxconn, which employs roughly 1 million people who manufacture all the iGadgets, invited journalist to its facilities and raised salaries as much as 20%, to $400 per month, in a response to all the bad publicity.
The hike in salaries could cost Foxconn some $1.2-$1.8 billion per year, which eventually will have to be paid by Apple and could put some pressure on its sky-high margins. Some consumer watchdogs remains skeptical about the whole working situation in the Chinese factories, and consider boycotting Apple products until the situation improves.
9. German privacy issues
Apple has long been considered a model company in regards to privacy protection. Its decision to have location tracking systems in its new iPhones and iPads raised a lot of controversy in Germany, which has some of the strongest data protection and privacy laws. The issue has raised awareness across the European continent, and other countries are considering their response to the issue of location tracking systems and new services such as iCloud.
It is hard to estimate how much further speculators and investors can drive the stock price up before an inevitable correction will occur. Diverging views between bulls and bears lead to a surge in trading and create a lot of short term volatility. Despite the valid arguments the bulls make in their case I think the world will eventually run out of Apple buyers and at least a mild correction will take place.