Apple, Buy Back This Stock

It's sitting on a huge pile of cash—and there are compelling reasons to return some to shareholders

Eighteen-and-a-half billion dollars is a lot of money.

It's more than the estimated 2007 gross domestic product of Nicaragua. It's bigger than the estimated 2005 expenditures of no fewer than 20 U.S. states. It's enough to give $60.78 to every person in the United States, and $2.77 to every person in the world.

And most importantly for Apple (AAPL) investors, it amounts to $21 for every share of company stock—and as of the end of most recent quarter, it's the cash pile sitting in Apple's coffers.

Time for a Buyback?

Shareholders certainly have shared in Apple's success over the years. The stock topped out at $199.83 on Dec. 28, an almost 19-fold increase over five years. Yet the growth in the company's cash hoard is starting to make people wonder, What exactly will Apple do with all that money?

Apple ought to return some of that cash to its shareholders in the form of a buyback. Apple may not have the biggest pot of money around. Cisco Systems (CSCO) and Microsoft (MSFT) both have more, in terms of absolute dollars, but on a per-share basis they have far less. Cisco's $22.7 billion translates to $3.80 per share, while Microsoft's $21 billion works out to $2.26 (and anyone following Yahoo (YHOO) knows well how Microsoft plans to spend it). Of the major technology companies, only Google (GOOG) boasts more cash per share than Apple: Its $14.2 billion works out to $45.37 a share.

And the time to buy back Apple stock is now. With the shares 40% below a historic high and the market nursing concern that Apple will suffer (BusinessWeek, 2/14/08) as the economy slumps and consumers curtail spending, an aggressive stock repurchase plan will do three good things for Apple shareholders.

Earnings-per-share Boost

First, it will send an unambiguous signal that management believes Apple's best days are ahead. Sure, iPod sales growth may be slowing for now, and there are concerns that iPhone revenue may be crimped as more people take advantage of so-called unlocking technology (BusinessWeek.com, 2/12/08) that lets them use the devices on networks other than those run by Apple partners. But there are lots of other reasons to feel bullish on Apple stock. The iPhone is going to be introduced in more European countries this year, and it may also be launched in China. Meanwhile, all the indications are that Mac sales will break the 10 million-unit mark in fiscal 2008, shattering 2007's record of 7 million.

Second, word of a buyback would probably give the stock price the kind of upward lift it needs. I found 295 companies on the S&P 500-stock index that have announced stock buybacks since the start of 2003, and they averaged a gain of more than 66% over five years. Gainers outnumbered losers by nearly 5 to 1, with the gainers improving their stock prices by an average of more than 150%.

Finally, reducing the number of shares outstanding—currently about 879 million—would boost earnings per share. And the size of that boost would depend on how much Apple is willing to spend to buy back its stock

Hypothetical Case

Let's stick with nice even numbers: A $10 billion repurchase would be enough to buy back about 10% of Apple's stock. Considering Apple's current valuation of about $110 billion, that would boost earnings per share by a healthy 10%. Analysts currently expect Apple to report earnings per share of $5.14 in fiscal 2008. How about $5.65? Or given Apple's tendency to beat estimates (BusinessWeek.com, 12/10/07), an even $6 a share?

A $10 billion repurchase would leave plenty of money lying around as a hedge for opportunistic acquisitions, though I don't see large ones on Apple's immediate horizon. As I've argued in the case of Microsoft and Yahoo (BusinessWeek.com, 2/8/08), big mergers don't work, and there are virtually no huge companies out there that Apple should consider acquiring in the first place.

Adobe (ADBE) is a name that gets tossed around once in awhile as a potential acquisition target. But with Adobe at $20 billion and change, it's too expensive; Apple would have to take on debt to pay a sufficient premium. What's more, there's practically no value to the combination. Apple's current professional software offerings overlap with Adobe's offerings. Plus Adobe sells a good deal of its software to Windows users.

On its face, an acquisition of TiVo (TIVO) might make a little sense. Currently valued at less than $1 billion, TiVo could be snapped up by Apple for a song—say, $1.5 billion—and TiVo's features combined with those of AppleTV. But why bother? Adding TV recording capabilities shouldn't be all that hard for Apple, and why would it want to support Tivo's existing subscription and set-top business, especially when it's losing money? In fiscal 2007, TiVo lost $52 million, on $258 million in sales, and when it next reports earnings it's expected to report a fourth year of losses. Apple management could probably right the listing TiVo ship, but why take focus away from building the iPhone, Mac, iPod, and AppleTV business lines?

When Apple buys companies, it tends to grab very small operations that are focused on developing a single product. The deals are usually so small they aren't reported until Apple files its 10K.

Flexible Enough

A $10 billion buyback would also leave plenty for Apple to use in negotiating its huge component supply deals with companies such as Samsung and Toshiba. It's not as if Apple is ever going to need to buy $8 billion worth of flash memory at one go. There would even be enough left over to start that venture capital fund I've been urging for about a year now (BusinessWeek.com, 3/1/07).

A buyback seems a better option than letting the cash, growing at a pace of $1 billion to $2 billion a quarter, sit all but idle, invested in treasury instruments, corporate paper, and other low-yield investments, especially in light of declining interest rates.

While I'm the first to praise Apple management for the smart way it has run the business over the last several years, its lack of plans for its cash is starting to ring hollow. CFO Peter Oppenheimer said during a Jan. 22 conference call that the company's preference is for maintaining a "strong balance sheet in order to preserve our flexibility to make strategic investments and/or acquisitions"

How much more flexibility does Apple need? And how much bigger does that pile of cash need to be before it's enough?