Apple Benefits From Cash Allocation Talks, But It Still Needs A Better China Strategy

| About: Apple Inc. (AAPL)
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Fresh speculations surrounding the possibility of Apple (NASDAQ:AAPL) returning more cash back to shareholders have emerged recently, infusing the company’s battered stock with some life. Apple’s shares rose almost 4% over the past couple of days after the company issued a statement Thursday, seeking to clarify David Einhorn’s allegations about a proposed elimination of preferred stock from its charter. The company said that the proposal, which is up for vote at a shareholder meeting February 27, doesn’t preclude the issuance of preferred stock in the future, but merely requires shareholder approval to do so. Further, Apple added that its management has been in active discussions about ways to increase capital allocation to shareholders.

That last bit brought some amount of optimism back as the raging debate over cash allocation reminded investors of the huge $137 billion cash hoard that Apple has piled on its balance sheet. With the company generating over $50 billion in cash annually, there is a huge possibility of Apple announcing an even bigger dividend or a stock buyback scheme in the future. However, Einhorn believes that the most rewarding would be issuing preferred stock to shareholders, and has already forwarded a proposal to Apple seeking the issuance of preferred stock with a perpetual 4% dividend. While it would indeed serve as a near-term catalyst to the stock if Apple starts returning more cash to shareholders through whatever means it deems fit, we see the same as having little impact on the company fundamentally. Moreover, the cash allocation would be limited by the fact that Apple has a majority of its cash overseas, repatriating which would lead to tax concerns.

We maintain our $650 price estimate for Apple’s stock, about 35% ahead of the current market price.

Emerging Market Strategy Required

Apple could improve its fundamentals by coming up with a better strategy for the emerging markets where the iPhone is way too overpriced to make any meaningful dent in the market. Android smartphones are already breaking the price barriers at the low-end, infiltrating emerging markets such as China, where Apple doesn’t yet have a deal with the largest carrier, China Mobile (NYSE:CHL). 3G penetration in China is about 20% currently. Despite this, it has already become the biggest smartphone market in the world, Apple will miss out on a huge growth opportunity if it doesn’t find a way to mitigate China Mobile’s subsidy concerns. We are, however, optimistic that such a deal will happen in the future, and believe that this could be the next big catalyst for Apple’s stock (see Apple’s China Potential Could Be Limited By A Subsidy Compromise With China Mobile and Apple Could Have A $750 Fair Value If China Mobile Deal Works Out).

In order to benefit more from the China potential, it may behoove Apple to consider a cheaper iPhone for the emerging markets that does not compromise much on the build quality and margins, in a move similar to the iPad mini. This will also help lower the per phone subsidy costs and potentially help bring China Mobile on board. Such a move would also undoubtedly translate well to other developing markets that may want Apple’s iPhones but may find the subsidy costs and retail price tag too high (see Apple Needs A Better Emerging Markets Strategy).

See our complete analysis for Apple stock here

Disclosure: No positions.