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Apple, Icahn, And Returning Value To Shareholders

|About:Apple Inc. (AAPL)

News of Carl Icahn's stake in Apple (NASDAQ:AAPL) blew up the Twittersphere and news outlets on Tuesday, a testament not only to Icahn's influence but also to the Twitter medium. Icahn will surely provide more insight on his expectation for Apple, so far leaving us with a brief opinion on the company, saying "that a larger buyback should be done now" and that he believes the company to be "extremely undervalued." Let's take a look at why Icahn may believe Apple to be undervalued, and how the prospects of a share repurchase fairs for the stock.

Apple has a notorious cash position. As of the latest earnings call, Apple boasts $147 billion dollars cash on hand ("COH"). We won't get bogged down in the endless admonitions about what Apple has been missing out on by not spending much of its COH, but suffice it to say Apple could buy several companies (AT&T, Netflix and Waze come to mind) and still have plenty left over for research and development, new store openings, and the proverbial rainy day. It has been able to accumulate such a large cash position based on the high margins and sheer volume of units of iPhones, iPads and other products it sells. Former CEO Steve Jobs famously hoarded cash in an effort to keep Apple nimble, with plenty of dry powder should an opportunity arise. It made very few acquisitions since its COH began to grow exponentially, even as its cash dwarfed the GDP of several countries around the world. It was only until recently that Apple decided to return value to shareholders by issuing a dividend and beginning a share repurchase program, the one that Icahn finds to be too meager.

Apple began its dividend and share repurchase program, stating, "Even with these investments, we can maintain a war chest for strategic opportunities and have plenty of cash to run our business. So we are going to initiate a dividend and share repurchase program." When a company repurchases its own shares, the upshot is that it essentially reduces the number of shares held by the public. The "float" is consequently reduced, and even if profits remain the same, earnings per share increases (the numerator, earnings, stays the same, while the denominator, shares, shrinks). Notably, Icahn made no mention of the dividend that Apple pays, but instead intimated that the company should buy back more shares. Companies often decide to tinker with a greater share repurchase program than with increasing a dividend payout, since they like to avoid having to reduce the dividend in future leaner years, and would prefer to abandon or shrink a buyback program.

Tax implications of share repurchases versus dividend payments are also important. When a dividend is issued, shareholders are taxed upon their disbursement, after the company is already taxed when it earned the money (though in the case of multinational companies like Apple, what it means to be "taxed" is an entirely different story). With a repurchase the company pays nothing to the taxman; the shareholders that sell back to the company, however, do pay capital gains on their profits.

According to Icahn, Apple is undervalued; therefore, buying more shares now could help the market correct the undervaluation, and Apple could then reissue them for a profit. Apple's large COH position could conceivably withstand a much higher payout for a share repurchase program than initially designed, a $10 billion plan at first. This represents less than 10% of Apple's COH, so it will be interested to see how much Tim Cook and the folks at Apple decide to increase the number, if at all. It is unlikely that the dividend is increased by much, as the aforementioned danger of reducing it in future leaner times could have lead to an adverse reaction among shareholders.

The market cheered Icahn's announcement, with the share price up around 20 points at the time of writing this article. This unadulterated bounce could obviously be the result of several aspects of Icahn's tweet, from the prospect of a greater share repurchase program, to perhaps the simple fact that Mr. Icahn likes Apple, believes it to be undervalued, and has taken a financial stake. It is just the latest indicator of positive momentum for the stock, as Apple has rallied from sub-$400 per share earlier this summer to almost $500 a share today. This rally could continue in the near future if impending product launches are a success, as Apple has traditionally done pretty well over the back-to-school and holiday shopping seasons. The doldrums Apple's stock has been in so far this calendar year, vastly underperforming the market, could potentially be a thing of the past should the momentum continue. Keep an eye on the September product launch and on the holiday frenzy, and you could see Apple reward you handsomely, especially with Carl Icahn fighting for returning value to shareholders.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Stocks: AAPL