Think about it. Apple sold 33.1 million iPhones in 2013. It’s revenue for the year was $37.47 billion. Sure, the company also sold 14.1 million iPads, among other stuff, but as mathematical relationships go, it’s hard to beat that correlation.
But, it isn’t enough because it’s sitting on over a $147 billion in cash; it’s profit margins are down from 40% to 37%; it’s facing pressure from Samsung, Google and Amazon; it don’t do no stinkin’ cheap tablet or phone. It’s enough for you, me, Apple, everyone except the speculators and hedge funds who are now circling Apple.
And so Apple may be doing great but it is facing some turbulence ahead. The company is kind of stuck in the largest gilded cage ever known to man. It can throw off billions of dollars of cash. Sell more phones than anyone else. Sell its products at twice the price of its competitors without anything more than a cosmetic advantages, and yet, it has nowhere to go but here.
Here for Apple is a place where it has to doesn’t do anything different. The recently launched iPad Air is thinner, lighter, and has a better display. It’s more expensive than its predecessor. It probably has a bigger bill of materials. It has a Mac Pro coming out that does a Dyson on the coming world.
The problem is that the rest of the world is rapidly catching up to Apple in every department. The Kindle Fire HDX is probably the best tablet to buy this Christmas. The Galaxy S4 and LG G2 are just as good, if not better, than any comparable iPhone. If people really cared about laptops and desktops, the MacBook Air would be bigger than it is, but Microsoft Surface can be just as cool if you are not blinded by Microsoft haters.
But, who is going to argue with the math. $147 billion in cash. That’s one tenth of all of the cash hoarded by US companies. It is the world’s biggest company by value.
But, it’s still not enough. That’s how weird the world has become. Below is Carl Icahn’s letter to Tim Cook, CEO of Apple, a few days ago. The gist of it is, Apple, borrow some money against all that cash you have abroad, give it to the shareholders. This is the Twilight Zone for Apple. It can’t really move much either way. It just has to do what it does, but it isn’t enough.
October 23, 2013
1 Infinite Loop
Cupertino, CA 95014
It was a pleasure meeting you for dinner at the end of September. When we met, my affiliates and I owned 3,875,063 shares of Apple. As of this morning, we owned 4,730,739 shares of Apple, an increase of 22% in position size, reflecting our belief the market continues to dramatically undervalue the company, even when taking into account the recent market appreciation, which in turn makes our proposal unchanged with respect to a $150 Billion buyback. We were pleased to hear at our dinner that you appreciated our input and that you would speak to us again in three weeks to continue the dialogue. In anticipation of doing so soon, we aim to reiterate in this letter the point of view already expressed to you directly with the hope of effectively summarizing it for the company’s board of directors and our fellow shareholders.
From our perspective, Apple is the world’s greatest consumer product innovator and has one of the strongest and most respected brand names in history. We consider Apple to be our most compelling investment. I first informed my followers on Twitter on August 13, 2013 of my “large position.” I also expressed to you my opinion that “a larger buyback should be done now.” At that time, we owned 3,448,663 shares and the stock price was $467. Since then we have purchased an incremental 1,282,076 shares (bringing the total value of my position to $2.5 Billion) and we currently intend to buy more.
We want to be very clear that we could not be more supportive of you, the existing management team, the culture at Apple and the innovative spirit it engenders. The criticism we have as shareholders has nothing to do with your management leadership or operational strategy. Our criticism relates to one thing only: the size and timeframe of Apple’s buyback program. It is obvious to us that it should be much bigger and immediate.
When we met, you agreed with us that the shares are undervalued. In our view, irrational undervaluation as dramatic as this is often a short term anomaly. The timing for a larger buyback is still ripe, but the opportunity will not last forever. While the board’s actions to date ($60 billion share repurchase over three years) may seem like a large buyback, it is simply not large enough given that Apple currently holds $147 billion of cash on its balance sheet, and that it will generate $51 billion of EBIT next year (Wall Street consensus forecast).
The S&P 500 trades at roughly 14x forward earnings. After backing off net cash, Apple trades at just 9x (not factoring into account that the company has a significantly lower cash tax rate than the rate Wall Street analysts use). This discount (cash adjusted) becomes even more compelling given our confidence that Apple will grow earnings per share at a rate well in excess of the S&P 500 for the foreseeable future. With such an enormous valuation gap and such a massive amount of cash on the balance sheet, we find it difficult to imagine why the board would not move more aggressively to buy back stock by immediately announcing a $150 Billion tender offer (financed with debt or a mix of debt and cash on the balance sheet).
While this would certainly be unprecedented because of its size, it is actually appropriate and manageable relative to the size and financial strength of your company. Apple generates more than enough cash flow to service this amount of debt and has $147 billion of cash in the bank. As we proposed at our dinner, if the company decided to borrow the full $150 billion at a 3% interest rate to commence a tender at $525 per share, the result would be an immediate 33% boost to earnings per share, translating into a 33% increase in the value of the shares, which significantly assumes no multiple expansion. Longer term (in three years) if you execute this buyback as proposed, we expect the share price to appreciate to $1,250, assuming the market rewards EBIT growth of 7.5% per year with a more normal market multiple of 11x EBIT.
It is our belief that a company’s board has a responsibility to recognize opportunities to increase shareholder value, which includes allocating capital to execute large and well-timed buybacks. Apple’s Board of Directors does not currently include an individual with a track record as an investment professional. In my opinion, any further delay in executing the buyback we hereby propose will reflect this lack of expertise on the board. My firm’s success and my expertise as an investor would be difficult for anyone to argue. Per my investment thesis, commencing this buyback immediately would ultimately result in further stock appreciation of 140% for the shareholders who choose not to sell into the proposed tender offer. Furthermore, to invalidate any possible criticism that I would not stand by this thesis in terms of its long term benefit to shareholders, I hereby agree to withhold my shares from the proposed $150 Billion tender offer. There is nothing short term about my intentions here.
Chairman, Icahn Enterprises (IEP)
Carl Icahn, and there are plenty more like him, they’re going to get that cash, and they’re circling Apple now because they can sense a weakness. Hard to see with all that bling in your face, but it’s there. Apple, a victim of its own success? Maybe.