Analyzing Proposals To Spend Apple's Cash

| About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) is a cash cow. In its latest quarterly report, Apple listed $10.1 billion in cash, $18.4 billion in short-term marketable securities, and $81.6 billion in long-term marketable securities. In total, Apple is carrying $110 billion in cash and investment securities on top of 929,277,000 shares outstanding. This means that, at $600 per share, roughly $120 worth of your Apple investment is in cash and investments. To help sustain this asset position, Apple generated at least $31 billion in cash from operations over the past six months. Running a corporation that mints cash is certainly a good "problem" to have for management. The goal remains to avoid mistakes.


Right now, Apple is the largest corporation in the world and boasts a $560 billion market capitalization. Apple would therefore need to make a significantly large acquisition in order to move the needle. At these levels, there will always be speculation for a $10-$50 billion cash and stock deal. Perhaps we should page Warren Buffett.

In the olden days (before the Internet), Buffett would have recommended that Apple take a look at media companies as a natural extension of its empire. At Apple's size, Sony (NYSE:SNE), CBS (NYSE:CBS), News Corp (NASDAQ:NWSA), Viacom (NYSE:VIA), Time Warner (NYSE:TWX), Comcast (NASDAQ:CMCSA), and Disney (NYSE:DIS) are all within range. Interestingly, these big media empires are worth a mere $294 billion combined. Yes, before the Internet, I feel that a union between Apple and the big media corporation of its choice would have been a match made in heaven. Ironically, the Web 2.0 era of iTunes, YouTube, Amazon Kindle, and Facebook has effectively decimated the long-term potential for big media investments. I am hopeful that Apple brass will also agree and forgo a disastrous big media acquisition at any near-term market top.

In terms of technology, I feel that Apple will continue to embrace the Steve Jobs counterculture of developing products in-house. I therefore think that a major technology acquisition is out of the question, especially since most Web 2.0 corporations continue to burn through cash.


On March 19, 2012, Apple announced plans to pay its first dividend in 17 years. According to the company, it will authorize dividends "sometime in the fourth quarter of fiscal 2012." Apple's Q4 begins on July 1st and the company will pay out its $2.65-per-share quarterly dividend during that time. These payments would calculate out to be a 1.8% dividend yield if Apple was to maintain its current $600 share price into the near future. In nominal terms, these dividend payments would total roughly $2.5 billion each quarter, or $10 billion annually.

Although Apple cheerleaders applaud every snippet that comes out of Cupertino, I cannot allow myself to jump for joy over dividend payments from a corporation that's still in growth mode. Over the past five years, Apple has averaged 65% annual net income growth, which arrives courtesy of its 42% return on equity. Cash spent on proposed dividends may have therefore been put to better use to ramp up production and drive more sales.

As a corporation, of course, dividend payments cannot be expensed for tax purposes. As an individual investor, your 2012 dividends will be categorized as either ordinary or qualified dividends to the IRS. Ordinary dividends are taxed at ordinary income rates that range between 10% and 35%. Alternatively, qualified dividends are either tax-free or taxed at a maximum of 15%. Lower tax rates are more applicable for long-term shareholders because you must hold stock for more than 60 days during the 121-day holding period around Apple's ex-dividend date for qualified dividends.

Today, the U.S. must grapple with a $15 trillion national debt and $60 trillion worth of unfunded Medicaid, Medicare, and Social Security entitlement programs. I expect higher tax rates on dividends going forward, especially because the investor community is always an easy target for populist rhetoric.

Beyond tax consequences, I feel that these dividend payments will also exacerbate volatility in Apple stock. Apple dividends will allow for open season on shares from growth and income mutual fund managers who now have the green light to buy in. Retail investors can be a curious lot, who often redeem shares in a panic and pile on amid boom times. Fund managers would then be forced to sell stock to meet redemptions at the bottom and also jam money into financial markets at the top. Numerous studies on stock splits hypothesize that shares become more volatile after splits, when smaller investors join the party and start trading.

Of course, I will grudgingly accept Apple's dividend, but I would rather have kept the cash flow as retained earnings underlying shares that could be sold at a later date for capital gains.

Share Buybacks

As part of its dividend announcement, Apple also announced plans to spend $10 billion in share buybacks within the next three years. I applaud this move because I feel that Apple shares still offer solid value at $600. Share buybacks obviously destroy shareholder value -- when well-meaning corporations blow cash to purchase and retire wildly overpriced stock on Wall Street.

Apple's $10 billion buyback plan may retire 16.7 million shares outstanding over the course of three years. Total shares outstanding would therefore fall from 929.3 million to 912.6 million. Let's assume that Apple's annual earnings were to stall out at $50 billion during this time frame. After the proposed share buyback, earnings per share would automatically increase by $5 to $58.8, from $53.8. If we use a capitalization rate of 7%, then Apple profits will carry an $840 ($58.8 / 0.07) per share intrinsic value after the buybacks, compared to $769 ($53.8 / 0.07) beforehand. The $10 billion buyback could translate into a $71 per share increase in shareholder value, as opposed to the $10.76 ($10 billion / 929.3 million outstanding shares) per share value that it carries now on the books.

Well played, Tim Cook, well played.

Disclosure: I am long AAPL.

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