The Case For Apple's Special Dividend

| About: Apple Inc. (AAPL)

By all measures, Apple (NASDAQ:AAPL) is now the world's leading corporate cash cow. For its latest 2012 fiscal year ended September 29, Apple closed out its books with $121 billion in cash and securities on the balance sheet. This formidable liquidity position is largely the result of Apple's reported $51 billion in 2012 cash flow from operations. Apple executives reign from the catbird seat - with plenty of cash to burn. Shareholders, however, remain in the game to maximize total returns, which would include both dividend reinvestment and taxes. Financial markets are now effectively paralyzed, as lawmakers debate solutions to help close today's ballooning deficit gap. Dividend tax cuts, of course, remain on the table. Peter Oppenheimer, Apple CFO, can make a calculated move to return capital to shareholders before the looming and effective expiration of the Economic Growth and Tax Relief Reconciliation Act of 2001.

Dividend Tax Rates

The colloquial term "Bush Tax Cuts" is now in reference to the Economic Growth and Tax Relief Reconciliation Act of 2001, and its effective extensions by way of the Jobs and Growth Tax Relief Reconciliation Act of 2003 and Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. These legislative decrees establish a dual schedule for dividend income, in order to encourage long-term investing and economic growth. For corporations, financial managers are tasked with decisions to either pay out after-tax income as dividends, or reinvest capital back into the business as retained earnings.

Passive equity income is now classified according to qualified and ordinary dividend definitions. Investors receive qualified dividends when they own stock for more than 60 days out of a 121-day holding period surrounding the authorized ex-dividend date. Ordinary dividends therefore typically apply to short-term trading. Qualified dividend income is either tax free, or taxed at maximum 15% rates. For tax-free qualified dividend income, a single filer would report less than $35,350 in 2012 taxable income to the Internal Revenue Service. 2012 ordinary dividends are taxed at the normal 10%, 15%, 25%, 28%, 33%, and 35% brackets. A single filer enters the 35% tax bracket when he reports more than $388,350 in taxable income.

The Bush Tax Cuts are automatically set to expire heading into 2013. At that point, classifications between qualified and ordinary dividends will cease amid a new era of more aggressive tax collection. The 2013 tax brackets are likely to shift upwards to 15%, 28%, 31%, 36%, and 39.6%. Tax bills for wealthy investors will more than double, as Treasury officials demand that investors "pay their fair share." At this junction in history, the tax burden on the investor class is likely to increase over the next several years.

Calculating Apple's Special Dividend

In 2004, Microsoft announced plans for a one-time, $3 special dividend. At the time, Microsoft (NASDAQ:MSFT) share prices oscillated between $25 and $30. At these levels, investors may target a special dividend yield of more than 10% on cash rich technology companies. Apple stock now trades for $585, after a steep two-month decline from $705. This deterioration in shareholder value parallels speculation concerning weakening iPhone 5 sales, fiscal cliff rhetoric, and stalled earnings growth.

Amid recent volatility, Apple shareholders are now well within their rights to advocate for a one-time $30 special dividend to be authorized and paid out at some point during the next eighteen months. In terms of timing, it would be ideal for Apple's special dividend to be made payable on December 31 to shareholders on record as of December 10. Apple, however, would risk significant losses to its own investment portfolio, if it immediately sells off fixed securities in order to distribute these dividends to shareholders.

For fiscal year ended September 29, Apple reported 929 million shares outstanding within its latest 2012 annual report. A $30 special dividend would shift $28 billion off the balance sheet and into the immediate possession of shareholders. Last fiscal year, Apple allocated $151 billion towards the purchase of marketable securities. This investment activity does include $113 billion in proceeds from sold and maturing financial assets. In 2012, Apple spent a net $38 billion on the purchase of securities. $28 billion of this $38 billion worth of investment cash flow can be reallocated towards financing activities and dividend payments.

Again, Apple reported $121 billion in cash and marketable securities on its latest balance sheet. Apple lists this position above $58 billion in total liabilities. This balance sheet can be broken down further to $63 billion, or $68 per share in net liquidity. Apple remains well within its means to issue a special dividend, if global markets avoid Black Swan total collapse.

Investment Strategy

The case for a dividend payment of any kind is typically comparable to rearranging chairs on a deck of the very same ship. In theory, shareholders maintain rights to corporate cash, whether it is retained as earnings on the balance sheet, or paid out as dividends. In terms of tax rates, shareholders must navigate a similar schedule for both dividends and realized capital gains. As of now, lower long-term capital gains tax rates are applicable to Apple shares held for more than one year, rather than the required 60-day holding period for qualified dividends. This slight differential in timing may be removed after the Bush Tax Cuts expire.

In any scenario, a special, one-time dividend limits financial risks and helps unlock real value for savvy Apple investors. Rather than accumulating cash on Apple's balance sheet, conservative investors may lobby for dividends and reinvest this cash into tax-free municipal bonds that side step Uncle Sam and preserve real returns. Aggressive investors may consider commodity plays, such as gold and oil claims, as a home for reinvested Apple dividends. Real assets typically strengthen in value as the dollar weakens.

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.

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