Thursday, July 29, 2010

It'll be OK

It's ok that Apple's selling all the iPhones and iPads that it can make.
It'll just make some more. Who wants to have made more than it can sell?

It's ok if there's more competition. Choice is good. And people will keep choosing Apple.

It's ok that some or most media outlets get a kick out of bashing Apple.
That's just how journalism works: "If it bleeds, it leads."
It's ok that Apple makes them look like idiots, time and again.

It's ok that Apple's the second largest and soon THE largest company by market cap. It deserves it.
It's ok if it sells just a tenth of what XOM sells. It sells "magic," while XOM sells nasty crap.
Out of every dollar worth of "magic" it sells, it gets to keep more than 3 times what XOM keeps
of its dollar's worth of shit. And the "magic" sales are growing while the other crap's in decline.

It's ok that Steve Jobs is mercurial, and snarky, and boastful. If anyone has earned that right, it's him.
And it's ok that he's getting older, and wiser. His asset is his mind, not his body.
And when he decides to retire, be that in 5 or 10 years or whenever, it'll be ok.
Whoever takes his place will surely have logged thousands of hours with a great mentor, and Apple will do fine.

It's ok that Apple keeps tight control over its platforms. Everyone does.
Ask "open-loving" Google if they'd be willing to share, not the free apps and services, no,
their search algorithms, which drive their ad platform, with competitors. It'd be the most idiotic thing.
Just like Microsoft's "industry standard" Windows and Office are closed games, and everyone pays to play.

It's ok that Apple hoards $46b in cash, and that it keeps adding to the tune of $500 per second.
I don't care for a dividend (it gets taxed, and Apple has much better ideas how to use it than I)
or a stock repurchase (its shares really don't need such an artificial prop, and cash is cash).

It's ok that AAPL is not part of the Dow Industrials. I see no benefit in that.
Why should it be? That's a bunch of established, mature, sometimes dying old farts.
Apple is quite the opposite: "the largest startup."

It's ok if everyone already has some AAPL. Everyone will soon wish they had more.
It's ok if it'll set them back $260 (or soon $400). It's more than worth it. I don't care for a split.

It's ok if yesterday and today AAPL fell 1% more than the market did.
It's UP a gazillion more than the market over the last 6 months, a year, 2, 5, 10 years,
or any other period longer than a few days. And it'll keep doing that for years to come.

It's ok if the sling-shot game is on. Otherwise we couldn't take advantage of it.

I'm not an Apple apologist. I'm a "fanboy" to the extent that the term implies admiration and satisfaction derived from the object of fandom, not of blind faith or sheep-like subservience. These are not by any means excuses made to justify or disregard any short-comings from Apple or AAPL. All of these, to me, are pluses.

Call me a contrarian if you want. It's worked out quite nicely for me.


Anonymous said...

Share buybacks aren't always a prop. It would've been best for a buyback to happen at $100, or even now if AAPL knows it is undervalued. Much better than sitting in cash.

Daniel Tello said...

Anon, please help me understand the benefit for Apple as a whole.

Say they take $2.6b out of the coffers for a buyback. This would allow the retirement of 10m shares. Say the shares outstanding were 910m and now goes to 900m shares. Lets ignore for the moment that the 10m retired shares may not even be enough to cover share dilution from employee options compensation. So, EPS would increase by about 1%, all other things being equal.

Then the theory is, the next day the market sees this 1% higher EPS and goes, oh alright we should be willing to pay 1% more for each share of AAPL, now that its earnings per share are 1% higher. Now that's a relatively loaded assumption. Apple has increased EPS by much more significant amounts and the market has ignored it. But lets go with it and assume the market is fair about it this time.

So, AAPL goes from $260 to $263. All shareholders benefit. Market cap remains the same (260*910m=263*900m). Net earnings remains the same, revenue, growth, etc. It's exactly the same company (as a whole) except for one thing: there's $2.6b less in Apple's coffers. Why is the company worth the same with the cash as without it?

More technically, how does the "self-investment" trickle down into the shareholder equity line on the balance sheet? If there are less assets to offset the same liabilities, doesn't that mean shareholders' equity would decline?

To sum up my doubts: even if the market is efficient and investors do get to see the appreciation in their shares, how is Apple as a whole not worse off with $2.6b less?

Robert Paul Leitao said...


I enjoyed the prose.

Indeed, the sling-shot game is on. Patience has its own rewards.

Robert Paul Leitao

eric said...

Nice piece deagol, I wish I had written it but I've never distilled my feelings so clearly and consisely.

To me, a share buyback is short term thinking. It's a manipulation of finances. Apple take a long term view. They raise shareholder value through innovation and flare. It's not instantaneous but over the long run it's proven a winning strategy. In these troubled times I'd rather $46 billion in cash and the flexibility and security that brings.

Thanks again for the nice piece.

Anonymous said...


"XOM sells nasty crap"

without that crap, a company like Apple wouldn't exit at all.
Without Oil, there is no modern civilization. You may find this out if you like another 20 years and remember this.
Think Peak Oil.

Daniel Tello said...

Anon, I know we all depend on that stuff. That's why XOM was worth more than $500b a couple of years ago. It'll still take a long while, but we're moving on from depending exclusively on it. There's wind and solar and stuff. Hopefully XOM will eventually move into that as well, but I bet they'll never get back to the good ol' days of earning $45b off of it.

NostraThomas said...

@anon#1 Apple is cheaper now then it was when the share price was $100.

@anon#2 XOM sells a product with enormous hidden costs. These costs show up on the ethical balance sheet of an XOM share holder's conscience. Not true for AAPL.

The main point is: These are the times we "hold" and wait for the market to catch up. (Correct me if I'm wrong, Deagol)

John Stetenfeld said...

Once again, Daniel, you are my hero! I've just sent a copy of your poignant prose to all of my thinking friends!!! (Apple Fanboys, and not...)

Lee Penick said...

Hi Daniel,

I would like to see apple do a buy back, but make the purchases when the market goes into it's frequent dips and panics.

Supports the share price.

reduces outstanding shares

increases EPS

Doesn't get the shareholder double taxed like a dividend.

Doesn't keep the money rotting at a low rate in a money market.

Now if Apple needed it to build a plant and expand further, with it's very nice growth rate, I wouldn't mind that at all. But I perceive their cash as excess, growing fast, and but being productively used for the shareholders benefit.

With that portion, I would like to see a share buy back program.


Soeti said...

Apple aplle apple - i see this anywhere((
If Google is God then Apple its an idol

Your blog in a private spam lists and usage for doorways. Be careful

Daniel Tello said...

"Your blog in a private spam lists and usage for doorways. Be careful"

Thanks for the heads up Soeti. I see one or two spam comments every once in a while, which I simply delete. Not a big deal so far. What do you mean by "usage for doorways"?

Anonymous said...

hello deagol. thanks for all your posts.

I have a question...
It is my understanding that Apple will provide "free bumper cases" to all those who purchased the iphone 4. And from the July Steve Jobs "antenna conference"...I am assuming that approx. 3 million iphone4s were sold. So...I understand that the initial 3 million iphone4s will "require" a bumper case...But what about the iphones sold after the first 3 million??? Will they require bumper cases as well? In other words...if someone buys an iphone4 a few months from now...will they need a bumper case? Or is the problem be the point where the newer iphone4s don't require a bumper case?


Andy M. Zaky said...

Very nice commentary Daniel!

Daniel Tello said...

Anon, I don't think every iPhone 4 user would "require" a case. Not all of the 3m sold by Jul 16, nor all of the millions that will have been sold by September. iPhone 4 does not "require" a case to function properly, except in some very specific circumstances.

But, I suppose many who might not have needed a case will ask for one anyway, now that it's free. Any iPhone 4 bought before September 30 qualifies (you must apply within 30 days of purchase or Aug 22, whichever date is latest).

iPhone 4 Case Program

@Andy, thanks. Very nice yourself on the valuation article. IMO AAPL's getting real close to the level of disconnect from Jan09 (or already worse by some metrics). What's your take on the current forward PE or EV/FCF, as compared to last year's lows?

JavaJack said...

I don't like where the stock is sitting right now. Yes, I know it's a US stock but it shouldn't be SO affected by what's happening in the USA when Apple itself is doing so well. Oh well, what can I do?

Anonymous said...

Daniel, regarding your buyback scenario. A buyback does make sense for a company that is growing its revenues and profits provided it has excess cash beyond what it needs for acquisitions and capital expenditures. In your example you just need to look beyond the next day to the next year or so.

In the case of Apple earnings and the share price (assuming all else remains constant) will be higher next year and the year after. So just imagine that the 10 million shares in your example are tucked away under Steve's' mattress; they will be worth much more than $263 in a couple of years.

Or to look back in history, suppose that Apple had repurchased 100 million shares when the stock was at $80 a couple of years ago. Plug that into your model and see where the share price would be today. Much higher. The key for repurchases are three: 1) The company must be growing profits, 2) the stock must be cheap, and 3) the cash used must be excess.

I enjoy your posts, as always.


JavaJack said...

Did everyone see this growth in use of Macs by the government? Wow?

Daniel Tello said...

Thanks capa. I do understand why the price per share would be higher due to the lower number of shares outstanding.

But, if as you say the financial gain relies on the shares being tucked under Steve's mattress (retired or held as treasury stock), doesn't your "investment gain" hypothesis imply that those shares would potentially get sold (reissued) at the presumably higher future price? Wouldn't such a reissue negate the anti-dilutive benefit? If so, the real long-term benefit would derive from successful stock trading and timing of the repurchase/reissue (buy/sell), just like we all aim to achieve. Correct?

The other question is, for Apple as a whole instead as on a per share basis, how does the balance sheet reflect the transfer of the cash asset into an increase and not a decrease in stockholders' equity, as some people suggest a repurchase would achieve?

Thanks for the link javajack.

Anonymous said...

Daniel: Along the theoretical calculations you were making, consider the flip side of secondary offering of stock. The shareholders lose, the market cap remains the same, net earnings do not change and the company has more cash than the day before. The symmetrical opposite move benefits the shareholders ( theoretically ). We all own a bigger share of the company.

Sacto Joe said...

Hi, Daniel,

LOVED the piece! I only sporadically check this site so I was pleased to find it. Talk about reading my mind!

I'm holding Apple long (at least two years before I start pulling anything out) as part of my retirement strategy. So days like today (Apple dropped below $240!) are basically water off a duck's back.

On the subject of share buyback, I've been doing some thinking recently about this whole issue of Apple's growing pile of cash and cash equivalents. One of the things I suspect is that, much like Apple's business in general, the growth of excess cash is exponential right now. On the other hand, Apple's stock price seems to be fairly linear. Over the last five years it's gained about $50/share.

What's fascinating to me is that, if these trends continue (linear increase in stock price but exponential increase in cash holdings), then theoretically Apple's cash would eventually equal Apple's market cap! But long before that point, Apple's shares would become a powerful magnet, inexorably pulling the price per share into something at least as exponential as the increase in cash holdings.

IMHO, that's one reason why holding long is an inevitable winner, and why letting the cash pile grow is "good" for stockholders.

But something you said has got me thinking that there may be some advantage to Apple to a stock buyback. You said "Lets ignore for the moment that the 10m retired shares may not even be enough to cover share dilution from employee options compensation." Fair enough, but you never went back to that point. And I think it bears some more thinking about.

One thing that Apple definitely does is reward its employees with stock purchase plans. Accordingly, a lot of Apple employees have Apple stock. So a buyback, in effect, rewards those employees (and ex-employees). That is extremely good for Apple as a company, since it adds a real incentive to (1) become an Apple employee (i.e., attract the best and the brightest) and (2) help the company grow (thus feathering your own nest).

Do you see anything wrong with this logic?

Anonymous said...

Theoretically speaking, one can ask the following questions regarding the cash. Let us say $30 Billion of what Apple has can be spent and the remaining money plus cash flow from continuing operations is enough to maintain their anticipated growth rate.

1) 30 Billion is earning 0.75% interest when it is in cash.

2) We are all holding Apple stock for a return better than that. If you apply the same principle to that cash, then it stands to reason that Apple should buy Apple stock. Either they keep it as treasury stock or reduce the float.

3) The third alternative for investing that money is to buy companies out right whose conservative PE to Growth ratios are much lower than Apple. Of course, Apple can not buy any company willy nilly but among the companies that fits with Apple, it should do that. Otherwise, they can as well buy Apple. Buying outright companies from an investing point of view is a bit whacky but that is what Berkshire Hathaway does. This provides for some diversification compared to buying Apple stock.

4) Invest the money in high growth mutual fund ( it can be Apple's own fund ) whose combined PE to Growth is lower than Apple.
This provides more diversification than alternative 3

Holding on to that much cash that is not needed for maintaining the growth rate is not a sound financial decision ( it is probably a sound emotional reason given what they went through back in the late nineties )

Sacto Joe said...

Hi again, Daniel.

I just can't seem to let this go. According to Google Apple has seen a growth in outstanding common shares for fiscal years 2006 through 2009 of 17 million shares. I assume that's the "share dilution from employee options compensation" you were talking about. Assuming a stock value of $250/share, that's about $4.44 billion dollars worth.

The thing is, why keep diluting shares? Why not buy the shares off the market instead? Aside from the fact that shares are cheap right now, there are intangible rewards to Apple for doing this, as I've already pointed out above. I contend that those intangible rewards would be worth at least as much to Apple as its "short term investments", which as of 2010-06-26 equalled some $14.6 billion.

Just wondering....

Daniel Tello said...

Joe, I don't mind the current rate of dilution from employees exercising their options. 17m shares (it's 18m over the last 4 quarters, not 2006 through 2009 according to my data) represents less than 2% of the outstanding shares or less than $5 on the stock. The earnings growth covers it more than sufficiently (if only the market would notice).

If Apple were to try to stop the dilution and spend $4b or more a year on repurchases, I'm afraid this market, as it's looking for any excuse to contain AAPL, would focus on the depletion in cash and discount the market cap by that amount, which would not help to push the stock higher. This is just an intuitive feel I have of this current market, but in a more conducive economy I'd certainly agree that the high likelihood of stock appreciation would merit at least stopping the dilution, if not going further and moving more aggressively.

In just a couple of quarters (by March 2011) I estimate the cash pile will grow close to $60b, which is a level that, after excluding about half of it for working capital needs, allows Apple a lot more flexibility than in the current uncertainty-driven environment.

I disagree with anon above and most others that think there's $30b excess cash right now (some count on the whole $46b and some even suggest they should use more by issuing debt given how cheap it is right now). I assume about $20b in current annual working capital needs (but growing) and add $10b for whatever other strategic purposes, so we're left with $16b. Sure, some would say I'm ignoring any future generation of cash to fund these needs, but my thinking on this is that Apple would rather have it already in their coffers before announcing any big moves instead of using it now and feeling a little tight for a while as the cash is replenished quarter after quarter.

Since that hypothetical $16b excess becomes $30b in a couple of quarters, I think being patient, especially in this market, is the right approach. There's a big difference in how far that would push the needle (buyback or whatever else). I think there may be a few specific (yet secret) very compelling strategic reasons why Apple is being patient. Perhaps it's a matter of waiting for some critical piece to fall into place. I'm against some big acquisition and instead think Apple is thinking of building something really big themselves, or picking up several small parts on the cheap.

Employees are already getting nicely compensated and incentivized. Right now I can't think of any other company that even comes close to offering the combination of workplace environment, personal achievement/satisfaction, and potential for stock compensation windfall than working at Apple.

Again this is just my intuition and it may turn out to be wrong if this right here is the bottom and we are about to rally to $400 in a few months. I definitely agree with you that AAPL is undervalued right now, I'm just wary of the markets. Thanks for sharing your thoughts and please keep them coming.

Anonymous said...

I am also on the bandwagon that Apple should borrow given the rediculously low interest rate environment we are in. In one or two quarters if the cash pile increases and the stock for some reason goes down to 200, apple should take some major steps. Spend 50% cash in hand and borrowed equivalent amount and buy back shares and also split the stock. Announce all that in one shot to maximize shareholder value. That will make the market take notice how confident Apple is about its own future.

Sacto Joe said...

Good points all, Daniel. Thanks for giving me some additional clarity on the "true" state of Apple's cash pile. I can't think of anything you've said that I'd disagree with.

I also have a "feeling". I think Apple has hit an exceptionally rich vein of opportunity. Their only "problem", if you can call it that, is going to be expanding at a sufficient rate to process it. I look at the issue of iPad and iPhone 4 unavailability as symptomatic. It's literally taken them months to get production of the iPad up to where they can satisfy demand.

To me, that suggests that even Apple's models have been too conservative. If I were Apple, I'd probably gamble a good chunk of that cash on OVER-estimating demand.

In any case, Apple's next couple of years are going to be very interesting!