Morgan Stanley recommends Apple use cash for share buybacks, dividends
Analyst Katy Huberty issued a note to investors noting that Apple's $76 billion in cash reserves represent 22 percent of its market capitalization. Of that amount, roughly $29 billion, as of the second quarter of calendar 2011, is held in the U.S., while $24 billion in foreign cash is believed to be eligible for repatriation without additional tax expenses.
Apple has lately been accruing U.S. income tax on about half of its foreign income, a rare move for corporations, according to Huberty. "We believe Apple is the only company in our coverage to accrue such a significant portion," she wrote.
Should the company elect not to return cash to shareholders, Morgan Stanley predicts Apple's cash balance will grow 58 percent year over year to $94 billion by the end of the year, and to $136 billion by the end of 2012.
According to the analyst, Apple's current and future cash flows "greatly exceed" its cash needs. Huberty notes that the company has historically used its cash for capital expenditures, component pre buys and small technology acquisitions. She sees capital expenditures for Apple reaching "a run rate of $5-6 billion in the next couple of years, depending on the pace of the company's data center expansions and the outlay for its new corporate campus in Cupertino, California."
Over the past four fiscal years, Apple has disclosed four major component prepayments — three for $500 million each and one for $1.25 billion. Meanwhile, small technology acquisitions have averaged $300 million per year during the same period. Huberty estimates that Apple's required annual spending will range from $6-8 billion.
Recently, the company implemented a "relatively new use" of its cash: bulk patent purchasing. For instance, the company spent $2.6 billion on the Nortel auction, which sold off the a collection of more than 6,000 patents.
Huberty's conservative estimate of Apple's cash flow stands at $34 billion in calendar 2011 and another $42 billion next year. Those amounts are "significantly more" than the company needs for expenditures, she wrote.
As such, Morgan Stanley put forth three hypothetical uses for Apple's cash balance: repurchase shares, initiate a dividend, or make a multi-billion dollar strategic acquisition.
According to Huberty, stocks of tech hardware companies that have returned more cash to shareholders through share repurchases have outperformed their peers. She suggests that Apple complete a one-time $25 billion share repurchase followed by a smaller, long-term repurchase program. By reducing the number of outstanding shares, a share buyback program would raise the company's Earnings Per Share.
Though the specifics of any possible buyback would depend heavily on the current stock price and the terms of the deal, Huberty cites one example assuming a $380 stock price and $25 billion worth of buybacks. According to her, that would result in 7 percent accretion to Apple's calendar 2012 EPS, while lowering the company's share count by 66 million shares and forfeiting $125 million of interest income.
The firm also notes that tech companies that have initiated a dividend, have also historically outperformed their peers. Huberty claims Apple would face minor EPS dilution from the corresponding cash outflow, as lost interest income from a $9 billion dividend payment would only amount to $45 million.
The firm's suggested third option of making a substantial acquisition "brings the most risk," Huberty said. She asserted that large-scale mergers and acquisitions have historically had a negative impact on acquirers' stocks. She did, however, note that an acquisition with revenue synergies that help the company increase the "already formidable moat around their device-driven business model" could prove accretive for Apple.
The analyst went on to suggest that a large deal would make sense for the company if it brought in "significant subscription-based earnings" by selling services or content to complement Apple's business model.
For its part, Apple has said it is hanging on to its cash reserves to take advantage of "strategic opportunities." Last year, then CEO Steve Jobs dismissed the possibility of a dividend, noting that the company prefers to keep its powder dry for big moves.
Apple has also been said to leverage its cash balance by offering upfront cash payments to secure competitors and block out competitors. Earlier this year, Tim Cook, who then served as Apple's chief operation executive, revealed that the company had entered into $3.9 billion in long-term component supply contracts over the next two years. In the past, Apple pre-purchased a billion dollars of flash RAM, a move that Cook called an "absolutely fantastic use" of the company's cash.
Bringing its internationally earned cash back into the U.S. could pose a problem for Apple if it decides to make a big move. The company is a member of a consortium lobbying for a tax holiday that would allow U.S. corporations to repatriate an estimated $1 trillion in overseas funds.
In July, it was reported that Apple's stockpile had surpassed the U.S. government's operating balance.