Why Apple Should Follow IBM's Successful Turnaround Story

By
A A A

In recent months, Apple's (Nasdaq: AAPL ) CEO Tim Cook has repeatedly stressed that the company still has a number of aces up its sleeve. Cook has dropped coy hints that bold new products are in the pipeline, so Apple could still surprise investors with better-than-expected growth.

But even if Cook is right and Apple is on the cusp of an impressive product release cycle, then he's wrong on one key point: Applewill never again be a great growth story it once was.

The company's annualrevenue base is fast-approaching the $200 billion mark, so even if the company is layered in tens of billions of dollars in new revenue, that would only offset some of the revenue declines the Apple will experience from maturing key products and competitive pressure, which could lead to more price cuts.


Make no mistake, it is Cook's job to focus on product development and technology leadership. But Apple'sboard of directors now has a completely different task: Boost astock price that remains in a free fall.

Luckily for Apple, another giant tech company once had the same image problem, and they managed to transition its message to investors successfully. "In 2005, IBM (NYSE: IBM ) was telling the Street it could growearnings double-digit, but the company was so complicated thatanalysts didn't believe it," wrote UBSanalyst Steve Milunovich. He's actually been following technologystocks since 1997 and has seen a number of companies manage to reinvent themselves through changes in capital allocation.

Milunovich draws parallels between IBM and Apple for a more prosaic reason: Both companies produce stunning amounts offree cash flow , thanks to returns on invested capital (ROIC ) that exceed 30%. In fact, while IBM's free cash flow has remained fairly consistent in the past eight years, Apple's has been exploding.

Apple's Stunning Free Cash Flow

Milunovich says it's time for Apple to join an emerging trend among technology companies. "IBM was one of the early vendors to deal withmaturity and make a strength of it by consistently givingback up to 80% of its free cash flow to investors," adding that " Intel (Nasdaq: INTC ) , Cisco Systems (Nasdaq: CSCO ) , and more recently Dell (Nasdaq: DELL ) and Texas Instruments ( TXN ) have made strong commitments to returningcash ."

Returning cash to shareholders is indeed a key reason why IBM'sshares have always fared well, even when the broader tech sector has slipped out of favor. IBM has boosted itsdividend by at least 13% for each of the past seven years, but thecurrent yield is a fairly unimpressive 1.7%.

Yet Big Blue's retirement of more than 500 million shares is more impressive. That has enabled IBM to more than triple its earnings per share during that time frame, even as sales growth has never exceeded 8% in any given year. This has attracted mega-investors such asWarren Buffett , whose stake in IBM is now valued at more than $14 billion.

So with Apple's free cash flow set to exceed $40 billion in the currentfiscal year , it's time to assess what Apple can do for shareholders. Let's assume, as Miluvonichnotes IBM has done, that Apple earmarks 80% of free cash flow each year (about $32 billion) to dividends and buybacks.

Allocating $8 billion each year to the dividend would translate into a roughly 2%dividend yield . Applying the remaining $24 billion into stock buybacks would shrink the share count by roughly 6% each year. Apple's board should actually show a great deal of flexibility on the matter. At times like this, when shares have fallen sharply in a short period of time, buybacks should be the main focus. When shares rebound (which they likely will if Apple pursues an IBM-style strategy), dividend growth should be the focus.

In fact, you could take this concept a step further. With nearly $140 billion in cash in the bank, Apple could return 100% of its annual free cash flow to shareholders and part with another $20 billion from itsbalance sheet each year. This works out to be $60 billion in playmoney , which could generate a 3% dividend yield and shrink the share count by 10% annually.

Risks to Consider: Buybacks can prove to be ill-timed if themarket tumbles lower in subsequentquarters . Companies such as Nokia (NYSE: NOK ) spent billions on buybacks, only to find they could have bought back alot more shares a few years later when share prices were lower. That said, judging by the metric of free cash flow, Apple's stock is already close to washed out.

Action to Take --> Investors are clamoring for Apple to take bold action to boost its flagging stock. It should become increasingly clear to the company that promising a rebound in growth will not be the panacea for this stock.

If Apple decides to make bold moves such as big stock buybacks and dividend hikes, then shares could quickly regain altitude. Even in the absence of any near-term actions, shares look quite washed out at roughly 10 times free cash flow. This once-hotgrowth stock looks like a more compellingvalue stock with each passing day, making it safe to hop on board, even as others are heading for the exits.


-- David Sterman

P.S. -- Corporate America is sitting on a $1.7 trillion "Dividend Vault" -- and it just might save your retirement. To learn more, click here.

David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of INTC, CSCO in one or more of its "real money" portfolios.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


This article appears in: Investing , Investing Ideas

Referenced Stocks: AAPL , IBM , INTC , TI , TXN

David Sterman

David Sterman

More from David Sterman:

Related Videos

Avatars of the Luxe Life
Avatars of the Luxe Life            

Stocks

Referenced

Most Active by Volume

48,622,216
  • $6.77 ▲ 11.72%
30,025,844
  • $7.75 ▲ 1.44%
29,613,078
  • $6.93 ▲ 3.43%
28,227,884
  • $17.365 ▲ 0.61%
23,519,609
  • $111.06 ▲ 1.51%
22,916,211
  • $44.485 ▲ 8.08%
21,525,525
  • $103.30 ▲ 1.47%
17,298,073
  • $7.79 ▲ 8.34%
As of 12/18/2014, 11:33 AM


Find a Credit Card

Select a credit card product by:
Select an offer:
Search
Data Provided by BankRate.com