Apple Needs to Loosen Its Purse Strings: Here's What It Can Buy

| About: Apple Inc. (AAPL)

I've noticed that there's been a growing divide between Apple (NASDAQ:AAPL) investors lately. Sure, when someone comes out with a bear case against the Cupertino Chocolate Factory, we instantly come together as one to tell them why they're wrong, but that doesn't mean we get along with each other all the time at the family dinner table. This latest feud is, of course, about whether or not Apple should start returning some of its massive cash hoard back to shareholders. With over $70 billion in its coffers after the last quarter's blockbuster results, this is a very good question to start asking. Dissidents of a return have presented their case: Apple needs its cash to secure favorable supply chain deals, they argue, or to outlast its competition in the event of a price war.

As a proponent for a shareholder return, I think it's time for me to step up to bat for my team. I agree that Apple operates in a very unpredictable and competitive industry and that it absolutely needs a vast amount of liquidity on hand to hedge against game-changing disruptions in its business. Money in the bank is also necessary to capitalize on lucrative opportunities that may come around ... for example, Apple's bigger war chest allowed it to shut out Google (NASDAQ:GOOG) in the Nortel patent auction. However, there comes a point when enough is enough, when there's so much rainy day money stuffed under the mattress that sticking any more under there would just make it impossible to get a good night's sleep. I think we passed that point at the $50 billion marker, and at $70 billion, we've left it in the dust.

Dissidents often point to past instances where Apple's cash secured a major competitive advantage for the company, such as when it spent $1 billion to corner the market on NAND flash right before it unleashed the iPhone upon the world. I would argue that they're giving credit to the wrong item on the financial statement - it was Apple's operating expenses that secured these deals, not its cash. Its cash is what Apple had left over after executing these strategic business maneuvers. Even then, $50 billion is more than enough to fund any unanticipated, but critical expenses in the foreseeable future. Any anticipated expenses can easily come out of Apple's $20+ billion a year cash machine, which many people seem to have forgotten about.

Apple is no longer the embattled company fighting back the tides of bankruptcy that it was in 1997, and I think it's time for it to consider sharing some of its newfound prosperity with its owners. That said, let's look at some of the ways Apple can deploy its cash to generate enduring value for shareholders.

Pay a Dividend

Let's face it: the only reason a long term investor would buy a stock is for the dividend. Capital appreciation is a trader's game - when you're like Warren Buffett, whose favorite holding period is forever, you don't give two hoots about capital appreciation. It doesn't have to be today's dividend ... often, instead of paying out its earnings right away, we want our companies to reinvest them so we can nab an even fatter dividend check in the future. Still, when we buy a company, we want it to eventually start paying a dividend. Otherwise investing is just a pyramid scheme, where everyone buys stock just to pawn it off on the next sucker at a higher price. Of the tech titans, Apple is one of the few that are still withholding all profits from its owners, and the only one in its weight class among all American companies. If Apple was to pay out just 50% of its trailing earnings in dividends, investors would be enjoying a very respectable 3.2% yield. Those seeking capital appreciation would likely benefit too, since one of the most popular theories about why Apple is so cheap despite its amazing growth is that it still has yet to pay a dividend.

Buy Back Shares

This is a tricky one, because a share buyback is a double-edged sword. Wielded deftly, it can carve up some prime cuts of value steak for the shareholder's dinner plate, but if the company swings it around foolishly, it's just as liable to hack off its own limbs. Travis Lewis analyzed other technology companies that have done buybacks in the past few years, like Microsoft (NASDAQ:MSFT) and Cisco (NASDAQ:CSCO), and he argued that in many cases, these companies ended up destroying shareholder value instead of creating it. The question all companies need to ask themselves before performing a buyback is this: is the current market price of my shares below their intrinsic value? If so, a buyback is a good idea, if not, it should be avoided. What doesn't make sense is that a lot of the opponents of an Apple buyback also believe the company to be undervalued at the same time. You can't have it both ways. Since the latest run-up, I believe that Apple is now a wonderful company at a fair price, so while I wouldn't necessarily oppose a buyback, I don't think it's as appealing now as when shares were trading at $315 a month ago.

Make an Acquisition

Here's one use of cash that both camps agree to be worthwhile, provided that it's employed wisely. Apple's strategy has always been to concentrate its resources on a few projects at a time, and do them well - it uses a sniper rifle approach to capital allocation, as opposed to a shotgun approach like Google's. However, there are lots of companies out there who have created products that would greatly enhance Apple's ecosystem. By acquiring these companies, Apple can develop new revenue streams and add value to its existing product mix without diverting the laser focus of its own R&D team or stepping outside its core competencies.

On the other hand, almost no company that Apple can potentially acquire will register much of a presence on top of its existing cash flows. Apple's pocket change is enough to completely buy out Netflix (NASDAQ:NFLX), Sirius XM (NASDAQ:SIRI), and Pandora (NYSE:P), and still its bottom line would barely twitch. For a company the size of Apple, the main goal for an acquisition should not be to juice up profits, but to build a competitive moat around its primary revenue drivers. One of the things that may hold Apple back if it decides to shift gears into a more acquisitive mode is its longstanding company culture of total control over its affairs. Companies usually like to retain a certain degree of autonomy when they join forces with a larger enterprise, and many of them may be turned off by Apple's infamous "My way or the highway" attitude.

Invest It

This is one use of cash that no one talks about because so few companies do it, but that doesn't make it any less effective. We know that investing in the stock market has been historically proven to be the fastest way to make money with money (otherwise why would we be here?), and this is just as true for companies as it is for individuals. However, most companies still choose to stow their cash in money market accounts or short term bonds yielding a pittance. Stocks are excellent investment vehicles that combine a high return with an acceptable degree of liquidity. So far, the only major corporation that has taken advantage of this option is Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B), and it has done so with devastating effectiveness.

Still, most CEOs aren't Warren Buffett, and most companies probably don't feel comfortable managing their own equity portfolio. These companies can benefit from adopting the same approach as Benjamin Graham's defensive investor: park their cash in a diversified portfolio of index funds, then sit back and watch it grow. The disadvantage of storing your rainy day funds in the stock market is that the times when you are most likely to need it, such as during a financial crisis, are the exact times when your holdings fetch the lowest market price. You also can't withdraw too much at once, or the selling pressure will sandbag your returns. Nevertheless, for a company with as big a treasure chest as Apple's, the stock market offers an attractive place to store a portion of its cash and earn a higher return than it's seeing now.

C'mon Apple, Nobody Likes a Scrooge

There's no such thing as too much cash, except when it's sitting on a company's balance sheet doing nothing. The biggest advantage technology companies have is that they require almost zero capital to expand, which means they can afford to return a much greater portion of profits to shareholders without sacrificing future growth. However, the thing about advantages is that they are no longer advantages if they're not utilized. Investors have been complacent so far given Apple's astounding growth over the last decade, but the uninspiring valuation that the stock has been trading at this past year indicates that Wall Street believes the company will begin to slow down soon. Adopting more shareholder-friendly policies may be just what the stock needs to put a little wind back behind its sails. I've written about how Apple is now all grown up. The thing about being a grown up is that you have to begin to take responsibility for things ... it's time Apple began living up to its responsibilities to its shareholders.

Disclosure: I am long AAPL.

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