Analyst to Apple - Shareholders want some of that $46 billion you got stashed!!!

Analyst to Apple - Shareholders want some of that $46 billion you got stashed!!!

Summary: Toni Sacconaghi, analyst at Sanford C. Bernstein, believes that the time has come for Apple to do something constructive with that $46 billion pile it's sitting on - like give some of it to investors.

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TOPICS: Apple, Banking
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Toni Sacconaghi, analyst at Sanford C. Bernstein, believes that the time has come for Apple to do something constructive with that $46 billion pile it's sitting on - like give some of it to investors.

Bottom line, investors aren't getting a good enough return on the cash, Apple isn't being clear about what it's going to do with the cash, and investors are also nervous that Jobs and the board could blow it on pointless acquisitions.

Yes, it seems that a company can have too much cash.

Here's the full text of Sacconaghi's letter to Apple [emphasis added]:

Dear Apple Board,

Over the last five years, Apple has done an extraordinary job in (1) creating breakthrough products such as the iPhone and iPad; (2) innovating on its existing product line; and (3) fostering a loyal and growing customer-base. Most importantly for shareholders, these actions have translated into earnings growing a stunning 10-fold, resulting in Apple's shares appreciating 487% over the last five years (2nd highest among all S&P 500 companies), while total returns on the broader market were -1% (see Exhibit 1). Moreover, the company has exercised exemplary fiscal discipline throughout this growth phase - both in controlling expenses (see Exhibit 2) and avoiding costly acquisitions; for all of these outcomes its shareholders are doubtlessly grateful.

However, in our conversations with shareholders, one common source of frustration - which is now bordering on exasperation - has been Apple's burgeoning cash balance and the company's unwillingness to return it to shareholders or discuss its vision for how the company plans to use it. Apple's cash balance is of mythic proportions - higher than the total market cap of all but 49 of the S&P 500 companies (see Exhibit 3), the highest among all US listed companies (see Exhibit 4) and growing - FCF has been $14.3B over the last 4 quarters and we expect the company to generate nearly $20 billion in FY 11. We implore you to consider returning cash to your shareholders, along with a longer-term road map for how you plan to use your cash balance and why.

A return of cash to investors makes sense for several reasons:

Current cash levels are excessive relative to what Apple requires to run its operations. We estimate that - at most - Apple requires $10B in cash on hand to run its ongoing operations. Given its negative cash conversion cycle and strong cash flow, it may require much less, but we do appreciate the fact that the company had outstanding off-balance sheet third-party manufacturing commitments and component purchase commitments of $6.2B at the end of FQ3 10 which its cash balance may help guarantee/fund; however, even if we assume that Apple does need $10B to operate the company, that still leaves $36B of excess cash.

Prevailing returns on cash are very low, destroying shareholder value. Apple earned 0.76% interest on its cash reserves vs. an implied expected return of ~11% on the stock - this large negative spread on cash indicates that holding onto excess cash is eroding shareholder value. Moreover, several academic studies point to a high correlation between return of cash and long term shareholder returns.

A return of cash would create financial discipline and alleviate investor concerns about a potentially imprudent acquisition. Apple's burgeoning cash balance creates the perception that the company may spend it on large acquisition(s) that shareholders believe might be value-destroying longer-term. While we acknowledge that Apple has been disciplined in this regard, with a history of making relatively small acquisitions for talent and technology only, this investor concern is longer- term and based on what has historically transpired at other companies. A return of cash and/or a transparent policy around use of cash would help alleviate this investor concern and ensure financial discipline on current and future management teams at the company.

• A return of cash to shareholders could attract a new class of investors. While Apple is widely owned today, there are investment managers with mandates that they invest only in dividend-paying stocks. Additionally, some investors are ideologically opposed to investing in companies that lack a clear policy on cash usage. Furthermore, several investors have told us that they discount Apple's large cash balance when valuing the company given that return of cash is neither imminent nor certain.

• Dividends or share repurchases could potentially lead to multiple expansion and/or higher EPS. Given that 20% of Apple's market cap is currently invested in cash at low interest rates, it is harmful to shareholder returns. Return of a portion of this cash along with the articulation of a clear cash-usage policy would likely lead to a multiple expansion as shareholders' expectations of having a claim on the excess cash becomes more clear. Moreover, if Apple chose to use some of its cash to buy back stock it would translate into higher earnings per share (EPS).

Three broad options exist for a return of cash: (1) a one time dividend; (2) ongoing dividends, and (3) share repurchases. We believe that investors' bias - even in the face of changing tax laws - is for Apple to institute a regular dividend coupled with buybacks, but we would encourage Apple to engage and poll its investor base and potential shareholders to more systematically gauge sentiment. The majority view among shareholders we have spoken with is that a one-time dividend would be least desirable.

Our analysis indicates that a 4% dividend would have consumed about 65% of Apple's trailing 4-quarter free cash flow, leaving $4.5+ billion in excess cash for corporate needs, acquisitions and share repurchases. Even if Apple's earnings multiple expanded by 50%, a 4% dividend would amount to an estimated 71% of cash generated in FY 11, leaving $5+ billion in excess cash, above and beyond your existing cash balance of $46 billion. We note that a 4% dividend yield would not be unprecedented among technology companies; we think Apple should be a leader in returning cash to its shareholders and a 4% dividend yield would rank it among the top 10 technology companies (see Exhibit 5). Exhibit 6 provides expected cash flow payout ratios on alternative dividend rates.

A $30 billion share repurchase (65% of your current cash balance) would lower Apple's shares outstanding by 13%, effectively boosting EPS by a similar amount. Apple could consider ongoing repurchases in the open market, or an accelerated share repurchase (ASR), which has been used recently by other large cap tech companies, including HP and IBM (see Exhibit 7). Exhibit 8 provides a sensitivity analysis of the size of buyback vs. share count reduction, based on Apple's current stock price.

Given Apple's powerful cash generation, arguably both a dividend and share repurchase could be done in parallel. Using our assumptions of a 4% annual dividend and $30B immediate buyback, Apple would still retain an estimated $25 - $30 billion in cash on its balance sheet at the end of FY11, providing ample financial flexibility.

Perhaps most importantly, we encourage Apple to engage in an ongoing dialogue and be more transparent with shareholders about cash usage. As Board members, you are legal stewards of shareholders' interests, and our conversations with shareholders suggest that they have not been fully heard on this issue.

Topics: Apple, Banking

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30 comments
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  • Note to shareholders

    shut up! This is *my* company. You merely lent me the money to allow me to grow *my* company. Mine, I tell you!

    regards, Steve
    honeymonster
    • RE: Analyst to Apple - Shareholders want some of that $46 billion you got stashed!!!

      @honeymonster - agreed. Shareholders, like customers, only have one function: To hand out their hard-earned money.
      HypnoToad72
    • RE: Analyst to Apple - Shareholders want some of that $46 billion you got stashed!!!

      @honeymonster - Yes. You don't see Microsoft having to hand over their stash. While Apple is set to have a larger hoard than MS Microsoft at this moment still has more.
      The Danger is Microsoft
      • RE: Analyst to Apple - Shareholders want some of that $46 billion you got stashed!!!

        @The Danger is Microsoft
        so much hate.
        Stan57
      • RE: Analyst to Apple - Shareholders want some of that $46 billion you got stashed!!!

        @The Danger is Microsoft

        MS pays dividends.
        rtk
  • Whats the problem here?

    If people are willing to buy a stock that does not pay dividends, then what is the problem? Let them invest in a company that pays dividends, like Google. What? GOOG doesnt pay either???
    I think it is safe for Apple to have a generous cash reserve for the acquisition of technologies and companies that will propel them to higher and better products as well as paying for large scale projects - NC Server Farm - . They are in a race against Google to acquire the best technologies possible, so if you want dividends it is very simple. Trade your stock and buy something that pays dividends. I would rather have a 200 percent increase in my stock than a 2-3% dividend.
    smartin007
    • No problem at all

      @smartin007<br>Exactly, Apple is still growing right now and it will need the money to fend off Google. By doing this, Apple's stock prices has risen. This has increase shareholders' wealth. What has Google done for investors lately?
      iPad-awan
      • Missing the point (both of you)

        @iPad-awan

        There is a very high likelihood that the shareholders will ultimately be able to invest that money better than Apple will. Continued significant growth of Apple in the mobile IT sector is unlikely. If Apple were to diversify, using that money, the shareholders would probably be better off if they did the diversification on their own.

        My prediction is that Apple will ultimately squander that fortune if they do not give most of it to the shareholders.
        Economister
      • Who do you think owns that $46 billion?

        @iPad-awan <br><br>Jobs? No, you are wrong. The shareholders own that $46 billion. If Apple wants to own that $46 billion, they can simply buy back all stock and become a private company. Of course, that will cost them slightly more than $46 billion. :)
        NonZealot
    • RE: Analyst to Apple - Shareholders want some of that $46 billion you got stashed!!!

      @smartin007 - can't they make their own? Why buy out everyone else and give most of the merged staff pink slips? That helps the economy... not...
      HypnoToad72
  • RE: Analyst to Apple - Shareholders want some of that $46 billion you got stashed!!!

    Well, our portfolio has a nice mixture of dividend paying stocks and some (APPL included) that does not pay a dividend. We bought APPL for the growth potential. However, no matter how you look at it, the growth in the stock value does NOT include our wealth UNTIL we sell - period. So for a long-term investment a dividend paying stock is the way to go. If one choses to invest in a non-dividend paying stock then one must be prepared to sell in order to take advantage of the growth in the stock.

    As I see it, the analyst is correct. If APPL wants to keep long-term investors then they need to pay dividends. Otherwise, the stock just becomes a vehicle for traders who buy/sell at every turn of the stock. This does not provide the stability long-term investors want or need nor does it provide the stability a company needs. Right now investors are having fun riding the wave but that will eventually stop and most of us will sell hoping to get off the ride at the top. When that happens the the stock will plunge. Especially as the hedge funds try to make their numbers and are forced to take profits where they can.

    While I love growth in my stocks, dividends are what drive me to retain a stock. Otherwise it's just a trade.

    Dividends are the best way for a company to retain the long-term investors and every company needs long-term investors to keep the stock price stable - even the golden APPL.
    steeleblue_cactus
    • Well rather than complain why not move on?

      @steeleblue_cactus
      Go to a company that pays dividends. After all now I'm confused as to why you invested in Apple at all? After all you had to know Apple's policy on this and that there were other companies that paid dividends. Plus I'm betting if you sold your stock now to move that money to a dividend paying stock you'll get a good amount of money more than you originally invested so BONUS!

      Pagan jim
      James Quinn
      • RE: Analyst to Apple - Shareholders want some of that $46 billion you got stashed!!!

        @James Quinn

        I don't see his comments as complaining, just merely pointing out some facts in investing. He did say they bought AAPL for the growth potential.
        Yax_to_the_Max
    • RE: Analyst to Apple - Shareholders want some of that $46 billion you got stashed!!!

      @steeleblue_cactus

      Yes you (and the analyst) are correct, if Steve doesn't start giving dividends soon he will create a bubble that will suffer the moment the stocks drop even slightly.

      2010/2011 may be the peak years for apple, as I perceive difficulty in maintaining its growth due to increased competition of alternative quality products, and the growing resentment of some of its policies from its own customer base, resulting in losing customers as fast as gaining new ones.

      So in the second half of 2011 we could see a fall in apple share value resulting in sell orders if the dividend is not forthcoming, - having no stability as you stated.
      Whilst I doubt that apple will fall massively, if I had AAPL shares I'd be pressing for a dividend too. Until then I'd be getting ready to sell within the short term, 8~18months.
      toviz@...
  • Hey Toni, I'm sure Steve will get right on that!

    <i>"We implore you to consider returning cash to your shareholders, along with a longer-term road map for how you plan to use your cash balance and why."</i><br><br>Yeah, <b>that</b> is going to happen really soon.</b>
    matthew_maurice
    • You realize that shareholders own Apple, right?

      @matthew_maurice

      If Apple did not want to be owned by public shareholders, Apple should buy back all outstanding stocks and become a private company. Oh dear, Apple doesn't have enough money in the bank to do that. :(

      Sigh, it sucks to take money from investors and then actually have to be accountable to them. :(
      NonZealot
      • Every stock holder gets a vote you realize this right?

        @NonZealot
        So I'm betting that this guys represents what percentage of the vote? I'd say its safe to say less than half and so.

        Pagan jim
        James Quinn
      • Let's see them try to change the locks.

        @NonZealot [i]"Apple should buy back all outstanding stocks and become a private company."[/i]

        Why bother?! Steve Jobs is going to run Apple exactly as he wants and nothing is going to stop that, short of his cancer coming back and killing him. Hell, the only thing that would cause most stockholders to sell would be Steve's departure, via death or otherwise. So Toni can implore all he wants, but he'd be better off suggesting Mark Hurd find a different dinner date.
        matthew_maurice
  • 3-1 split better than dividends

    I'd rather take a 3-1 split when it hits $300 for my 12,000 shares I bought at $14 some years ago.
    Bob Forsberg
    • RE: Analyst to Apple - Shareholders want some of that $46 billion you got stashed!!!

      @Bob Forsberg - I agree. Same case with me ('cept I own 18,000 shares and bought it at $28 each).
      The Danger is Microsoft