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Icahn And Apple - The Good, The Bad, And The Unknown

|About:Apple Inc. (AAPL) Includes:Microsoft Corporation (MSFT), NUAN

On August 13th, activist investor Carl Icahn disclosed a large stake in Apple (NASDAQ:AAPL). This caused quite a steer on the markets which sent apple stock shooting up. Now, after a month has passed since Icahn's announcement and the dust has settled - It's worth taking a closer look at what this really means for Apple shareholders.

The good

Ichan is sending a strong signal to the market that Apple's stock is deeply undervalued. He's probably right. At a price-to-earnings of only 12.5x, and at a price-to-cash flow of a lowly 10x, the company seems exceptionally attractive both in absolute terms and in comparison to the broader market.

But the final destination of Icahn's signal isn't the market. It's Apple's management and Tim Cook in particular. In that sense, the purpose behind Icahn's move is to extract value from Apple. That's because merely sitting on a cash hoard of $147 billion (and counting...) is the classic definition of an inefficient deployment of capital.

Icahn wants Apple to increase its share buyback program from $60 billion to $150 billion by putting some of its cash pile to work and by issuing more debt at 3%. I'm a big advocate of share buybacks as long as they are executed at a convenient price. Since Apple's shares are highly undervalued right now- buying more of them is a very sensible move.

The bad

In a sense, Icahn's move might hurt Apple shareholders in two ways.

One, Apple's balance sheet will inevitably become more leveraged. This isn't necessarily a good thing. That's because the debt market is now in a totally different state than six months ago when Apple first raised $17 billion. It's now much tougher and more expensive to raise money.

Two, Icahn's announcement has caused Apple shares to climb higher, and faster. In fact, since Ichan's position was revealed Apple's shares have climbed from around the $460 level to more than $500. This might not seem such a big move at first glance, but a 9% increase in share price is a big deal when the company is in the midst of an aggressive share buyback program. Shareholders probably have been better off if the company had been able to quietly and gradually accumulate shares at $460 rather than at $500 and up. In a way, Icanh's victorious announcement came at the expense of existing shareholders, himself included.

The unknown

Whether Icahn's investment is successful or not remains to be seen. There are three points that remain deeply in fog.

  1. Apple has already engaged in a highly aggressive buyback program. Following Einhorn's pressure on the company, Apple has increased its then $10 billion buyback program to a staggering $60 billion program. It doesn't seem likely that Apple will consent to burden itself with another debt load just to increase its buyback program.
  2. Even if Apple miraculously agrees to Icahn's plan and ups its buyback program -it's still not a sure sign of a long term success. Microsoft (NASDAQ:MSFT), for example, has spent an aggregate amount of a quarter of a trillion dollars (that's not a spelling mistake) buying its own shares for the last 15 years. Yet, its stock price sits exactly where it was back in 1998, according to Forbes.
  3. Perhaps Icahn's real goal is not to make money on Apple but on a different company. Icahn controls 16% of Nuance Communications (NASDAQ:NUAN), the maker of the software that powers the voice feature in Apple's phones. The rumor is that Icahn intends to influence Apple's management to acquire Nuance. This will give Icahn a nice little bundle.

My conclusion

Whether or not existing Apple shareholders will benefit from Icahn's involvement with the company still remains to be seen. But the most important thing to keep in mind is that Apple shares are still deeply undervalued whether or not Icahn is a shareholder. I recommend to buy shares up to $550.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.