Trump’s victory in the U.S presidential election put a new gust of wind in Apple Inc. (NASDAQ:AAPL) sails, giving investors hope that the smartphone giant would be able to repatriate its $250 billion cash pile for a massive share buyback and/or a special dividend. But as Trump’s economic agenda becomes sidelined by other issues, the market seems to have moved on from the repatriation thesis.
In fact, even Apple’s management team doesn’t seem to expect cash repatriation anytime soon. Instead of waiting on politics, Apple is focusing on raising debt to buy back stock. This strategy reveals Apple’s transition from a growth stock to a dividend aristocrat – but is this good news for investors?
The Truth About Buybacks
Lately, Apple’s #1 priority seems to be buying back its own stock, and on the surface, this looks like a great way to deliver value to investors. The fewer shares are outstanding, the more each share is worth, right? Not necessarily. Buybacks do not benefit investors by boosting stock price. In fact, buybacks are usually net-neutral in terms of influencing the price of a stock.
The capital used to buy back shares has an opportunity cost. And using it to buy stock instead of investing in something else isn’t necessarily a value accretive use of funds – even more so when the buybacks are financed with debt instead of cash. Not only does the expenditure have an opportunity cost, but it also comes with interest expense and a liability (long-term debt) on the balance sheet. As counter-intuitive as it sounds, equity dilution – issuing more shares – can be a better boost to a stock’s price than buybacks, provided the cash raised is, or is expected to be, successfully used to create value.
Growth investors don’t necessarily benefit from share buybacks, so who does? Income investors. Why? Because while buybacks don’t necessarily boost a company’s stock price, they do boost earnings per share (EPS) and the total amount of dividend paid per share. Apple paid a total dividend of around $12.15 billion last year. And by reducing the number of shares outstanding, the company can keep cash outflows for the dividend low while growing the dividend per share indefinitely.
Apple’s Debt Situation: The Numbers
In the most recent quarter, Apple only spent $2.77 billion on research and development while spending $3 billion on cash dividends paid. Capital stock reduced by $6.88 billion, and debt increased by almost $11 billion. This use of capital may look weird to growth investors, but this is Apple’s way of ensuring that it can deliver value to investors no matter what happens to its top line.
On the surface, the exponential growth in Apple’s long-term debt looks bad. But there is a method to the madness. Remember, Apple’s $250 billion cash pile is not actually held in cash. The money is held in short-term yielding assets – most likely ultra-safe debt securities.
It looks like Apple borrows money denominated in the same currency as its short-term yielding assets. This allows Apple to use the yield from its debt securities to pay off the interest on the debt it is borrowing. These transactions are probably done through complex financial derivatives to maximize efficiency and minimize the tax burden.
Apple has found a way to “spend” its cash without bringing it back to the U.S. And because the company’s balance sheet is so liquid, lenders are willing to loan it money at incredibly low interest rates, making this strategy a perfect solution to the issue of repatriation.
Apple’s success can be traced to, not only its innovation and creativity, but also its superb, far-sighted management strategy. While less skilled leadership would be tempted to force top line growth through risky acquisitions and R&D with diminishing returns, Apple is using the tried and true strategy that Coke, McDonald’s, AT&T and other iconic American brands used when their businesses matured.
Apple is still outperforming the market, but over time the stock’s beta will decrease and its performance will probably mean revert to the average. The good news is that Apple’s new focus on share buybacks, dividend growth, and dividend stability will ensure that the company outperforms the market on total return for years into the future.