Here’s this week’s TechCrunch column, this one looking at how Wall Street and hedge funds make sense of Apple’s recent decision to buyback shares.
Apple has a good deal of cash. And, in the Valley, the startup ecosystem — for many reasons — wants to see Apple spend that cash. As their cash pile continued to grow as their stock price and market cap soared, Apple’s inability to provide robust software services combined with opportunities to expand their reach through acquisitions has become a fancy parlor game which includes every stripe of public and private investor imaginable. On top of this, pumping even a small percentage of cash pile into acquisitions could provide another pool of much-needed liquidity for founders and investors alike. While it all makes sense on paper, part of what makes Apple “Apple” is that they operate how they want to — not how the market wants them to. Recently, in response to a variety of pressures to do something, to do anything, Appleannounced a two-part share buyback. There are many explanations for this financial strategy, and while the Valley may have their own armchair financial analysts with a Twitter account, I reached out to some friends who actually work in technology banking or at techonology-focused hedge funds and asked them to send me a paragraph on their perception of the move. Because of the world these folks work in, I’ve reproduced their answers below anonymously, as they are not permitted to publicly share their opinions on such matters:
Technology Investment Banker: With the amount of cash stock piled by Apple, and mainly overseas, it was only a matter of time until the water would break, especially with activist investor David Einhorn ruffling feathers. Apple did something very standard and not uncommon, but on a large scale the way Apple likes to do things. At the end of the day I feel Apple’s actions represent the following four points: (1) Increased Shareholder Value: There are many ways to value a profitable company but the most common measurement is Earnings Per Share (EPS). If earnings are flat but the number of outstanding shares decreases. . Voila! . . A magical increase in period-to-period EPS will result; (2) Higher Stock Prices: An increase in EPS will often alert investors that a stock is undervalued or has the potential for increasing in value. The most common result is an increase in demand and an upward movement in the price of a stock; (3) Increased Float – As the number of outstanding shares decreases, the shares remaining represent a larger percentage of the float. If demand increases and there is less supply, then fuel is added to a potential upward movement in the price of a stock; and (4) Excess Cash: Companies usually buy back their stock with excess cash. If a company has excess cash, then at a minimum you can bank that it doesn’t have a cash flow problem. More importantly, it signals that executives feel that cash re-invested in the corporation will get a better return than alternative investments. This is definitely a positive sign for the company going forward. Customers and investors should feel confident with these events transpiring that Apple will continue to deliver value to both parties respectively.
Technology Hedge Fund Principal: Since Apple has around $150B cash on the books (70% of which is foreign), it’s clear they need to do something with this cash because it’s just wasted sitting on the balance sheet earning low interest rates. People have assumed the market would respond well to Apple making acquisitions, especially in software and services, particularly in cloud and mobile software. While they have reaped the benefits of profits in mobile hardware, the value going forward is at the application and services layer. Other hardware manufacturers are catching up, if they haven’t caught up already. Unfortunately, Apple doesn’t seem to have an appetite for these types of acquisitions. Another option is to buy back shares, a proven way to deploy cash, though doing so sends a signal that they are a mature (read: not growth) company. Tactically, buybacks can decouple EPS growth from new product lines, and Apple could see 2x its buyback investment in earnings growth as a result. Ultimately, Apple has withstood significant pressure from the investment community to do something with the cash, especially as growth has slowed. (Venture arms, since you asked, are not an effective use of capital for a corporate player; I see the share repurchase as a much more responsible use of proceeds.
Hedge Fund Partner #2: Apple had four basic choices of what to do with their cash, remembering that apple has a duty to its shareholders: (1) Do nothing (status quo), which makes zero sense. given that they have ~$145Bn in cash and are adding ~ $40Bn in cash annually assuming zero growth earnings earning; (2) Strategic acquisition or expansion, though Apple will be hard pushed to effectively put either their cash hoard or future cash flows to use to do this; (3) a one-time special dividend and increased annual dividend; or (4) a share buyback (or various form of it). Only options #3 or #4 made any sense to me and I assumed it was only a matter of time before they did something. #1 is out as they are would not be meeting their shareholder responsibility and #2 is out simply because of scale.
I see the share buyback as positive for three key reasons: (1) Apple stock is currently very cheap. My back of the envelope calculations conservatively value them at $500-$550/share, so they are effectively leveraging and creating additional shareholder value here until the multiple recovers to fair value. What’s more is that management knows a lot more than what we all do, so they should be able to calculate their own value in two to three years fairly well, and I assume they saw this as a positive. (2) Because Apple issued bonds to finance the deal rather than using cash, this way they will not need to repatriate taxable offshore cash to perform the buyback and they will likely get a bond rate the crazy low prices. Bottom line, they are saving shareholders cash, although at some point they will need to find a way to address the offshore cash, so perhaps they are waiting for another tax holiday. And (3), assuming the market reacts rationally, a buy back signals that managements believes in stock and the story and believes that this will generate returns that will outperform for long-term investors, something that a cash hoard did not address at any level and effectively generate returns far in excess of what could be achieved in any other safe manner.
More often than not I do not like share buybacks. often management does this to boost their own salary bonuses (EPS biased etc) or simply follow bad advice and follow the investment banking herd, but this time I liked Apple’s share buyback at this share price and multiple and applaud the debt financing way of doing it, I would have applauded it more if they had also issued a $40 special dividend.
Hedge Fund Partner #3: The view is Apple has stopped being an innovator. While they were at the forefront of technology, people bugged them to use their cash for a dividend or buyback and they could say “no” because the stock price was going up on leading edge innovation. Once Jobs passed away, Tim Cook hasn’t been able to keep that going, and if anything they are now playing catch-up to Samsung or even Google. When you aren’t innovating and you have $150B in cash, a board has to find ways to keep investors happy and one tactic is to conduct a massive buyback. Showing they are returning money to shareholders, creating a new base if “capital return” investors rather than growth investors. It’s all a game to prop up the stock price, money is cheap because of Bernanke, so it’s an easy way for them to please shareholders without much cost to the business. In general, I think that Apple is falling behind and trying to figure out how to regain their lead, and I’m not sure if its possible any time soon.
Technology Stock Investor: They’re doing the buyback because: 1) they have an unprecedented amount of cash ($140+ billion) that’s earning nearly nothing; 2) the stock is down nearly 40% from its high and shareholders are angry; 3) the stock is cheap on every financial metric, signaling that buying shares is a good use of cash if you believe in the long-term growth of the company. The company does not appear to want to do a large acquisition or massively increase its capital expenditures. They don’t “need” to hold that much cash. So the company had a very inefficient capital structure ($140+ billion of cash and no debt). Equity investors (who, in the end, own the company) sooner or later demand to get returns on their companies’ cash. Capital markets are competitive, and if management doesn’t give investors great reasons to own their stock, investors will go somewhere else. AAPL is facing slowing revenue growth, margin pressure, and uncertainty about their next major product line. A management team that is perceived as unfriendly to shareholders is another reason for investors to sell the stock. The buyback is a big gesture by management that they understand their shareholders’ concerns, in addition to likely being a good investment.