Years from now, Apple employeeswill look back on April 18,
2013, as the day the company awoke from its slumber.
That day, Apple'sshares closed below $400 -- a price that was
inconceivable seven months earlier, when thestock was making a
bold run toward the $700 mark.
Why is a tumble below $400 a crisis for Apple? Because many of
its employees receivestock options , and a lower stock price
tends to make employees antsy. Apple can't afford a brain drain
when rivals like
are getting stronger by the day.
TheBalance Sheet Catalyst
Since he took the reins of
Apple (Nasdaq: AAPL)
in October 2011,CEO Tim Cook has insisted the company is doing
just fine and that it will focus on product development and not
its stock price.
That attitude was understandable when shares slipped below
$500 this January. He was right that there was no need to panic.
After all, that price still represented a 20% increase from where
shares stood at the start of 2012.
Now, with shares falling into the $300s, it is time for
About six weeks ago, I argued that Apple should mimic
and embark upon a large and ongoing stock-buyback program.
Radically reducing the share count was a masterstroke for Big
Blue. Apple, with its stunning levels ofcash andfree cash flow ,
can do even more on this front.
Yet the buzz is building that Apple can go further than just a
cash-fueled stock buyback. If the company takes action, shares
could zoom to $600 -- 50% higher than current levels.
That action?Put somedebt on the balance sheet, and use
thatmoney for buybacks, too.
The Right Time To Borrow
Typically, technology companies are debt-averse and like to
carrylots of cash on the balance sheet. That's largely due to
fears that an eventual economic slump might lead to a cash
crisis, as happened with the dot-com bust of 2000.
In Apple's case, it's virtually impossible to envision a
scenario in whichsales plunge, free cash flows evaporate, and the
company starts to bleed cash. It is plausible, however, to
envision a slow-growth future in which Apple'srevenues expand
less than 10% a year and free cash flow remains stuck in its
current range. (Free cash flow has exceeded $30 billion in each
of the past two years.)
Slow top-line growth and healthy free cash flow are thefactors
behind many companies' decision to shift from cash-rich,
debt-free balance sheets to moderate levels of debt. The tax
advantages of carrying debt are the main reason, although the
current environment of low interest rates certainly doesn't
Let's look at Apple's balance sheet to see how much debt it
could take on, and what that wouldmean for the share count.
At the end of 2012, Apple had more than $135 billion in net
cash. Thanks to robust ongoing free cash flow, that figure is
likely closer to $145 billion now. (Apple will release fiscal
first-quarter results April 23.) Second, let's conservatively
assume that Apple will generate $25 billion in annual free cash
flow in the years ahead. Third, let's assume Apple would be
willing to take on $40 billion innet debt .
The $185 billion swing in the cash balance, coupled with the
annual free cash flow forecast, would enable Apple to spend $60
billion on buybacks in 2013, 2014 and 2015, and roughly $20
billion on buybacks after that.
Spending $60 billion annually (assuming shares remain at $400)
would buy back 150 million shares annually, or roughly 13% of
Apple's current 934 million share count. (It stood at 947 million
at the end of fiscal 2012 in September.)
As Apple's share count shrinks, the percentage reduction in
the share count increases (assuming 150 million shares are bought
back each year). That would have the effect of nearly doublingEPS
, all other things being constant. If Cook has another plan to
doubleearnings per share (
) in just three to four years, he should share it with
Apple earns $40 to $50 a share every year. A massive share
buyback could boost this figure toward the $75 mark. Slap
amultiple of 8 on that EPS target, and shares would move up to
In the near term, Apple's woes may appear to increase. Though the
company will likely meet the consensus fiscal first-quarter EPS
forecast -- which has already come down from $11.84 to $10.13
over the past three months -- this stock is vulnerable to tepid
near-termguidance . For example, BMOCapital 's Keith Bachman just
lowered his second-quarter EPS forecast from $9.78 to $8.29, well
below the $9.28 consensus.
Bachman sees trouble on a number of fronts. "We have lowered
our unit estimates for iPhones, iPads, and Macs ... as well as
our gross margins for iPhones, which lowers our consolidated
gross margins," he recently wrote.
If his assumptions are correct, and Apple has to establish a
lower bar for unit sales and gross margins, this stock could
easily tumble lower. It's unclear whether the recent drop in the
stock anticipates that possibility, but it highlights the fact
that there's no reason to rush to buy this stock ahead of next
Yet it's unwise to write Apple off. It is still the best
consumer technology company in the world (though Samsung is a
formidable rival). I'm keeping a close eye on
turnaround plans as well.
However, no competitor -- not Sony, Samsung or any other
company -- will knock Apple off its perch. The installed base of
Apple disciples is too powerful. That's why this near-term
weakness is so intriguing: If weak second-quarter guidance pushes
this stock well below the $400 mark, then the long-termupside
scenario starts to really strengthen -- especially when Appleputs
its dormant balance sheet into action.
Risks to Consider:
Apple has a very largeretail investor base (individuals love
this stock even more thanhedge fund managers these days), and
these retail investors may get spooked by Apple's recent
sell-off, which could add to the selling pressure in the near
Action to Take -->
At any price below $400, Apple should be buying back stock --
lots of it. It's absurd to sit idly by and watch shareholder
value be destroyed. Though few may ponder the notion of a
debt-fueled stock buyback, look for the idea togain currency in