Why Carl Icahn Is Dead Wrong About Apple

Just weeks after being dealt defeat in the Dell proxy fight he started, activist Carl Icahn is making a comeback, and in a big way. On Aug. 13, Carl Icahn tweeted out that he now holds a large position in Apple, saying that he believes the stock to be extremely undervalued. In late October, Icahn shed some light on just how large his large position in Apple currently is, about 4.73 million shares, worth somewhere around $2.5 billion.

Icahn, who now owns 0.5% of Apple, has been much noisier than the average shareholder, and already has met with Apple (NASDAQ: AAPL  ) CEO Tim Cook to discuss a $150 billion share-buyback program, which Icahn is advocating as the proper way Apple should utilize its $147 billion in cash. Yet just because this legendary investor says something doesn't mean it's right. In fact, he is dead wrong about Apple.

Icahn's plan could send Apple shares to $1,250
While Apple has already launched a $60 billion buyback program it plans to enact over the next three years -- a plan which the company marks as the largest ever and one which it will revisit each year -- Icahn is unimpressed. He wrote in his letter to Cook that while it "may seem like a large buyback, it is simply not large enough given that Apple holds $147 billion of cash on its balance sheet."

Icahn continued on in his note to propose a $525 per share tender offer, facilitated by Apple borrowing $150 billion at a 3% interest rate. This, Icahn says, would result in an immediate 33% boost to earnings. After three years and with the benefit of earnings growth, Icahn sees shares of Apple soaring to $1,250.

While the short-term benefits of this program are indisputable, whether or not if this plan is in the best interests of long-term shareholders has come into question. Icahn said in the letter that "commencing this buyback immediately would ultimately result in further stock appreciation of 140% for shareholders who choose not to sell into the proposed tender offer," adding, "to invalidate any possible criticism that I would not stand by this thesis in terms of its long term benefit to shareholders, I hereby to agree to withhold my shares from the proposed $150 billion tender offer. There is nothing short term about my intentions here." Unfortunately, I'm not so sure.

Apple needs to start "thinking differently" again
While a rising share price is undoubtedly something I would cheer as an investor in Apple, over the long run emptying the vaults to buy back stock is not something that is going to keep the company growing 5, 10, or even 20 years from now. Instead, Apple should return to its innovative roots, and start "thinking differently" as it once did.

Just look at how Google (NASDAQ: GOOGL  ) (NASDAQ: GOOGL  ) is venturing into self-driving cars and Google Glass, two products which like the iPhone and iPad, were unimaginable before substantial investment by these companies. Or how Amazon (NASDAQ: AMZN  ) has poured millions into building the infrastructure required to support the rapid growth Amazon expects in its web services division. In 2012, this segment produced only $2.52 billion in revenue. In 2020, over $20 billion in revenue is expected.

A rising stock will come with growth, as the market rewards companies whose primary focus is investing in the future with hefty multiples. Amazon did not even make any money in the third quarter, while Google carries a P/E ratio near 30 compared to Apple's 13. While the passing of Steve Jobs undoubtedly took some of Apple's innovative magic away, there are countless great ideas and visionaries in the world, and Apple has the money and means to make these dreams a reality, and fuel the company's future growth in the process.

Recently rumors have been swirling as to if Apple will release an "iTV" early next year, but even if it does, this product must only be the first in a series of new products to come. One of the advantages of having $147 billion in cash is that not all growth must be organic, and major acquisitions are a potential reality. As a long-term investor in Apple, I would much rather the company buy Facebook and Netflix and still have $7 billion left over than spending all of its $147 billion buying back its own stock.

The Foolish bottom line
While I am glad Carl Icahn is bringing some attention to Apple's management of its cash, I strongly disagree with his storm-term minded share buyback program, and would rather have the company invest in the products of tomorrow like Google and Amazon. My respect for Carl Icahn is great, but at least on this one, he is dead wrong.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 07, 2013, at 12:48 PM, tangos88888 wrote:

    While I agree that AAPL needs to get back to its "think different" path you lost me when you said they should "buy FB or AMZN" Huh...??? Now??? Are you nuts? Please pass along what it is you are smoking. I thought Carl and Cook were crazy. Buying back shares makes sense when you have too much cash that is holding down the stocks value. There is not that much the company can do with that kind of money with taking huge risk. Yes, agreed buying NFLX is a good idea, but when the stock was $50 a share not at $350! Buying FB is the most ludicrous comment, at this nose bleed valuation. Do you understand what 150 billion is? It is an insane amount of money that cannot be used for any sensible valuation. A major acquisition like a Facebook would result in complete chaos to manage and would not be accretive to AAPL.

  • Report this Comment On November 07, 2013, at 1:31 PM, margiecfl wrote:

    Buy Facebook?? How the hell does that fit into Apple's business model/ plans? Just ruined the article for me

  • Report this Comment On November 07, 2013, at 2:28 PM, johnestromjr wrote:

    Ryan, I couldn't disagree with you more. First it doesn't have to be an "all or nothing" with regard to a $150 Billion stock buyback. Icahn is pointing out that $147 Billion [likely even more now] sitting in a big pile is not an efficient use of assets. If they needed it for acquisitions that would be one thing but they don't and never have.

    The idea of emulating Google or Samsung is a bit much and neither are all that innovative. What has that Android watch done? Zip. Google bought Motorola and is now making Moto X - which is losing money. They paid, as I remember, $13 Billion for Motorola and so far has lost $248 million on Moto X smart phones? Yeah, that's working for them. As for Amazon, you've got to be insane. ScamAzon has a P/E of over 3000 and you want Apple to emulate Amazon? Why?

    While buying back $150 Billion more of their own stock they should be aggressive in their stock buyback program. I would also suggest Apple increase the dividend substantially. Right now all sorts of "traders" are driving the stock into the dirt. A solid dividend of say 5% would virtually end that nonsense and make it the Blue Chip stock of Blue Chip stocks.

    Regardless of your criticism of Carl Icahn Apple investors need to see a LOT more business smarts from Tim Cook and that means maximizing the returns to its owners - the shareholders. We need financial people on Apple's BOD not fools like AlGore. What does HE bring to the table? Zip. Just my humble opinion - your mileage may vary.

  • Report this Comment On November 10, 2013, at 6:58 PM, jakelannigan15 wrote:

    Damn these commenters are mean. I agree with you Ryan these people are fools (pun intended).

    P.S.

    Get on the google doc

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