Prominent investor Carl Icahn made headlines in late 2013 with his letter to Apple (AAPL) CEO Tim Cook, which urged him to pursue a large share repurchase program in order to reduce the company’s outstanding share count and thus increase the proportional ownership of each remaining share, which would make them more valuable. He joins the ranks of shareholders and commentators who have taken issue with the gun-shyness of technology company CEOs who are sitting on cash hoards of tens of billions of dollars, yet have not put those dollars to maximal use despite the current environment of meager interest rates. Indeed, Mr. Icahn has pointed out that Apple can borrow money at such low rates that it may make sense to engage in a buyback of up to $150 billion (around a quarter of the company’s current market capitalization) at this stage.
Apple’s balance sheet boasted $40.7 billion in cash and marketable securities on its latest statement, a figure which has risen substantially over the past 12 months. The figure should continue to rise sharply if the company doesn’t start deploying capital far more aggressively. Further, AAPL has an additional $118 billion in long-term marketable securities.
It began paying a dividend last year, but the amount is minor relative to earnings. Indeed, we project that dividends will hover around 30% of net profits in the coming years, not nearly enough to prevent further cash accumulation. While the company has finally begun buying back shares, after many years of share dilution, the amount would have to be consistently more than it has been in past years now to begin drawing down the cash pile in a significant way. There has been evidence that the company is beginning to change its stance though. Recently, Apple announced it had taken advantage of a dip in its share price following disappointing December earnings, by repurchasing $14 billion worth of its own stock. It remains to be seen whether this level of activity will continue.
Part of Apple’s concern may be uncertainty over declining margins on some of the company’s key products. While it has continued to introduce new additions to its product lines, every field that it has innovated its way into has been flooded with tough competition and increasingly forced the company to compete based on price. Indeed, for fiscal 2013 Apple recorded its first year-over-year decline in earnings per share in over 10 years. (Apple’s fiscal year ended September 28, 2013.)
Microsoft (MSFT - Free Microsoft Stock Report) had even more cash & equivalents on its balance sheet, over $83 billion, at the end of the December quarter. Indeed, the figure has been rising by over $10 billion a year for the past few years. With an easily manageable debt load, and minimal capital spending needs, it remains unclear when the company will put the bulk of this growing mountain of cash to shareholder use. It has taken some steps in that direction, including growing the dividend at an annualized rate of 13% over the past five years, and share repurchases that have brought the common share count down from over 10 billion in 2006 to just over 8.3 billion today. Management’s caution, however, may come from a fear that the company’s current cash flow cannot be counted on to continue into the future, due to declining demand for PCs, and a history of difficulty in the consumer market (as opposed to the commercial and corporate arenas, where it has traditionally shown strength).
With capital spending needs that have been a small fraction of cash flows for many years now, it is unclear to some why the management of either of the companies mentioned above should be fearful of a less conservative financial structure.
As their cash hoards are dwarfed by massive market caps, none of these stocks should be bought solely on the strength of the company’s cash balance. However, when combined with their strong free cash flows, struggling share prices, and high dividend yields, they hold significant potential as value investments. The main risk is that the earnings of these businesses will decline as their core products mature and face new competition.
Indeed, at the core of Carl Icahn’s disagreement with some in the technology field lays the nature of the business itself. While Icahn has focused for much of his career on extracting the maximum value for shareholders in cash cow style businesses, the technology field is marked by an ever-changing landscape, in which competitors are constantly having to innovate to remain relevant and today’s cash flows cannot be taken for granted in the future.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.