Apple Should Expedite Share Repurchases
Ishfaque is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Apple's (NASDAQ: AAPL) cash hoard of more than $137 Billion is constantly in the limelight, and even more so with an activist investor raising additional concerns about the cash. After the recent sell-off of Apple shares amidst worries on margins and innovation, the companies dividend yield in excess of 2.2% looks quite decent.
The company announced a share repurchase plan worth $10 Billion until 2015, but primarily to offset dilution arising from employee stock options. With the stock languishing near 52 week lows, and the intrinsic value of the company slated to be much higher than the current share price, now is the time to ramp up that share repurchase plan for a much bigger buyback.
Low Interest Environment
The company's oversized cash balance is barely earning pennies on the dollar, as funds are primarily invested in government securities and investment grade corporate bonds in the U.S. and abroad. The weighted average interest rate for its cash and securities position for its most recent quarter was a paltry 1.07%.
Understandably, shareholders are questioning the company’s capital allocation strategies. With the Fed's stance pretty clear on keeping interest rates low until at least late 2014, returns from fixed income securities will remain poor unless further action is taken.
"Fooling All of the Shareholders This Time"
David Einhorn of Greenlight Capital raised eyebrows when he sued Apple and while he was simultaneously pushing the company to issue perpetual preferred stock with a 4% yield. Einhorn gained fame with his now famous book, "Fooling Some of the People All of the Time" and for short positions on Green Mountain, Lehman Brothers and Allied Capital. However, who is Einhorn really trying to fool this time?
Einhorn deserves credit for bringing the cash issue more into the limelight and paving the way for more thoughtful discussions. But it is pretty much a self-serving stance, and even more so, because his fund is in the red. However, the issuance of preferred stock is a pretty bad idea.
This shouldn't be a major surprise as Einhorn's fund lost a lot of money betting big on Apple stock and a short position on Green Mountain Coffee (NASDAQ: GMCR). Einhorn's bet on Green Mountain went sour after the specialty coffee-maker of the famous K-Cups rallied heavily after posting good numbers amidst worries of patent expirations, and a decent outlook for 2013.
Downsides of Preferred Stock
The preferred stock idea pitched by Einhorn might look very good on paper. But it’s actually a bad idea, preferred stock is just like vanilla debt except the obligations are not as harsh. Issuing tradable preferred stock is not going to alter or enhance the value of the company. Preferred stock has more senior claims relative to common stock, and as a result common-shareholders will actually be more subordinated in the hierarchy.
And most importantly, there is no tax benefit to be realized from preferred stock dividends. Interest from issuing straight debt is tax deductible, which provides a great incentive for corporations, which preferred dividends don’t have.
Current Buy Back Plan And Offshore Cash
Apple has already utilized a sizable portion of the buyback plan in place. In Q1 F2013, Apple already repurchased shares worth $1.95 Billion through an accelerated share repurchase program with a bank. However, due to the current low valuation of the stock, Apple should expedite the remaining balance of the announced share buyback program using multiple banks.
An impediment to doing a buyback is that more than two-thirds of Apple's cash is located offshore, i.e. roughly $94 billion. The company has to pay a massive tax bill at current corporate tax rates for repatriation. Apple is not the only company with this headache, arch-rival Google (NASDAQ: GOOG) also has a majority of its $48 billion located offshore, i.e. $31 billion.
However, both Google and Apple generate substantial amounts of Free Cash flow on an annual basis, and should not be a problem at least near-term. As a result, Apple can easily ramp up its buyback plan, and do a sizable buyback for driving the shares higher. Buying substantial amounts of stock have been a catalyst for sending the share price higher for companies like IBM and Yahoo.
Even if Apple wants to hold onto its conservative stance, it can use multiple foreign banks to borrow funds in this low interest environment. And can pay-off these foreign banks with offshore cash. As a result, it will be utilizing off-shore cash, and getting tax deductions for using debt in its capital structure as well. In addition, to making the buyback a catalyst, Apple can also pursue these alternative methods for creating shareholder value.
1. One Time Special Dividend: A non-committal one-time special dividend should calm down the nerves of investors. The no strings attached nature of special dividends is increasingly becoming a great alternative for many companies, as it gives corporations a lot more flexibility down the road.
2. Stock Split: There is no real value creation from a stock split. However, a stock split would open the stock up to more investors, and the market forces of demand and supply will push the price higher. This can be easily done to boost the current stock price with minimal effort.
3. Increase Dividend Substantially: This is the most straight-forward option, and also, the least desirable because it creates a major cash obligation every quarter and also creates tax obligations on recipients right away. However, Apple has a lot of cash to foot a sizable dividend increase and can do so with relative ease.
Apple can do a lot with its cash position. Giving the investors a one-time special dividend, in addition to its regular dividend, will settle the nerves of many investors, as it doesn't create a recurring liability either. Also doing, a stock split might be a worthwhile endeavor. However, the preferred stock idea pitched by Einhorn is clearly not the best available option.
Apple's CFO had hinted that the company might consider increasing the buyback, but hasn't confirmed. It is pretty evident that, a major value enhancing opportunity is available for the company to do an expedited buyback worth $30-$40 Billion at current prices, and still sleep very well at night.
ishfaque has no position in any stocks mentioned. The Motley Fool recommends Apple and Green Mountain Coffee Roasters. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!