We sought to pick a number that we thought would be more than sufficient for a rainy day fund. We took 1 year’s worth of operating expense and CapEx, less depreciation and came up with $20 billion. This, along with its ongoing franchise, should leave Apple well-positioned to execute its business plan, including acquisitions. While some have suggested that Apple could raise additional cash by selling debt, we believe that Apple is highly debt averse work even asking it to reduce the cash balance to $20 billion is probably not realistic. But, where the sake of this e xample, we believe it is a reasonable number. That leaves 80 fair $4 billion of free cash to use for a one-time dividend or a one-time self tender offer of its shares. A one-time dividend of the $84 billion in cash would come out to $89 per share of Apple common stock. Figure out how much value this would unlock, one has to guess how much credit the market is already giving Apple Inc. for the cash. If the market gives it no credit, than the dividend is found value which means the dividend would unlock the whole $89 per share. However, to the extent the market already gives Apple some credit for the cash, the amount unlocked would be reduced. There’s no way to know for sure how much credit market gives. So, there’s no way to know how much value will be unlocked, but the range is no less than zero and no more than $89 per share. The caveat is, that to the extent this would reflect Apple adopting a better capital allocation policy, such that cash and future cash aren’t trapped indefinitely, the market might reward Apple with a higher PE ratio.
We have two thoughts in this regard. First, if the change in capital allocation is done begrudgingly, the market will be less likely to give credit or recurring improvement. We think we saw that with Microsoft’s large special dividend a few years ago. Second, the benefit from a higher PE due to a more shareholder friendly attitude is available to Apple in each of the scenarios we will review today. As we prepare scenarios, you can build and whatever multiple expansion you think is right for more shareholder friendly capital allocation and apply it to each scenario. The only scenario that won’t approve the market sentiment on Apple is, of course, the status q uo. Let’s look at the second option. The one-time $84 billion share repurchase.
To get this all done at once, we assume a tender at $600 per share. This way, all the shareholders would benefit the same by tendering there prorated share. One could try a lower price but it doesn’t affect the outcome very much. Under this plan, Apple could repurchase 140 million shares, or about 15% of the out tending s hares, leaving 805 million shares outstanding. 15% fewer shares means 17% higher earnings.
You can see that EPS goes from $45 to about $53. We assume that the PE stays confident on the higher earnings, so the post tender value is $528 per share. When you blend the $528 per share on the 85% of remaining shares, with the 15% of shares tendered at $600, you get a combined value to shareholders of $539 per share. This scenario, Apple unlocks up to $89 a share in value. To the extent that the market is already crediting Apple for the cash, the PE post repurchase will shrink and the amount unlocked will be lower. Just like the one-time dividend, this plan will unlock between zero and $89 per share, the large repurchase is a more tax efficient way for shareholders to get to the same place.
In the next alternative, Apple could keep it’s current cash balance but use all it’s future cash flow generation to buy back stock. In this example, we maintain the current dividend and freeze the cash on the balance sheet at $137 billion. The fund of the repurchase we assume Apple uses it’s domestic cash until it runs out. Then, it’s which is to foreign c ash, which will require it to pay taxes as needed in order to execute the repurchase program and keep overall cash flat.
For forecasting purposes, we use current consensus estimates. His what the numbers look like over three years. When Apple pays out 100% of its future cash flow, it depletes it’s domestic cash sometime in 2014. Foreign cash continues to build until then, at which point it is used in the repurchase program and needs to be repatriated. This causes Apple’s cash rate to go up which drives free cash flow lower in 2015. We think that announcing a program of repurchasing stock with all future cash flow would unlock value. It would signal a more shareholder friendly capital allocation, fast earnings growth and confidence in the business. Calculating the value is harder, because it is sensitive to the share price assumption. Unless Apple’s valuation expands dramatically, which would be a good problem pop Apple should be able to buy back about 6% of it shares each year in this case.
We think Apple Inc. (NASDAQ:AAPL)’s shares would immediately re- rate by 10% to 20% as the market would price in a lower share count and higher earnings in 2015. While the EPS accretion would like the share reduction due to the higher tax rate, we would expect some multiple expansion on the fully taxed earnings in reaction to the mayor shareholder friendly policy. We assume an immediate 17% stock reprice bump followed by 15% annual appreciation. For the purpose of calculating comparisons to other ideas, we estimate that this plan will immediately unlock about Vavenby five dollars per share with more to come.
Now, there the conventional view that if Apple wants to return money to shareholders the best way to do so would be through a large dividend increase. In fact, that is the direction Apple took last year when it initiated a $10.60 annual dividend.
The conventional hope is that the stock would move up substantially and trade to a quote of the dead yield. The reality is, that equity investors value companies using a number of metrics that have little to do with the common dividend yield. And our experience, for the dividend yield to be the primary support for the stock price, it has to be rather high. There are a number of blue-chip companies trading at more than a 4% dividend yield, some of which we show on this slide. We believe that equity investors have to look to a wide range of valuation metrics and business issues when valuing common stock. The equity market is more interested in Apple total earnings and the business issues that drive those earnings.
Will the company maintain market share and operating margin? Will the beat earnings estimates? What new products will be introduced? These issues will most likely dictate the common equity valuation and trump the dividend yield m etric. Often when a stock with the low PE introduces our raises its dividend, it’s just become a stock with the low PE and an attractive dividend. Now that we’ve evaluated the for conventional means of distributing money to shareholders, let’s take a step back I consider Apple’s history. Apple is once in a hole so deep it had to go to Microsoft for money. Apple innovated its way out.
It innovated in hardware, in software, in retail, and in supply chain management. The strength of that innovation has left it in the fortunate position of sitting on $137 billion in cash and growing. But, when a third of the value of the company has cash, managing it requires the sort of attention one would normally reserved for operating the business.
In contrast to the rest of Apple’s business, where innovation has been the norm, Apple attitude toward managing it’s cash has been exceedingly non- innovative. It’s the one place where Tim Cook’s predecessor was adamantly opposed to innovation. Like Apple, we agree that one should take a conservative approach to managing cash. Fortunately being conservative and being innovative are not always at odds with one another. So, let’s consider Apple’s priorities. Apple wants to be able to continue to innovate and pursue its business strategy without having to rely on Wall Street. They want the flexibility to pursue acquisitions, both large and small. Under no circumstances does Apple want to put itself in jeopardy.
The clearest way to do that is to remain cash-rich and debt-free. That is just what Apple has done. Though Apple might not have considered it possible, we have a solution for unlocking value for shareholders that allows it to have its cake and eat it too. We have developed a brand-new capital markets product that offers Apple a chance to creatively maximize value for shareholders,
