Is Apple a Buy on Icahn's Plan?

Apple  (NASDAQ: AAPL  )  is still a relatively undervalued company, and big name investors like Carl Icahn are still singing the company's praises. The company is expected to see solid earnings growth over the holiday quarter and its deal with megacarrier China Mobile should drive upside in the first quarter of 2014.

Icahn, Apple's fanboy, is pounding the table and urging the company to ramp up its share repurchase plan and drive value for shareholders. And as a testament to his claim, Carl Icahn ramped up his stake in Apple by $600 million and now owns roughly $3.6 billion in Apple stock. 

Significantly cheaper than the overall market
Icahn's proposal to the Apple board is predicated on the company's cheap valuation relative to the S&P 500. The S&P 500 is trading at a multiple of roughly 19 times earnings, whereas Apple is trading at almost 14 times earnings. If Apple trades at the market multiple the value of the company would be north of $750, which represents significant upside from current levels. 

To narrow this valuation disconnect, the activist shareholder wants the iPhone maker to ramp up its share repurchase program to $50 billion in fiscal 2014. It's worth noting that Apple has roughly $37 billion worth of share repurchases left to execute until fiscal 2015, but Icahn wants another $50 billion on top of the existing program. 

There's a lot of truth to that claim of undervaluation, because Apple's CEO, Tim Cook, has stated in a number of occasions that Apple remains undervalued. If that is the case, the company can generate significant amounts of value for long-term shareholders by buying back its own stock at a cheap level and reducing its share count.

Icahn stated that the management is doing a great job, but its Board of Directors is doing "a great disservice to shareholders."  Apple's board should be more opportunistic in buying Apple stock at cheap valuations. Apple does have enough liquidity resources to go about running its business and pursuing other strategic M&A opportunities as well. The company has roughly $130 billion in net cash, and this overcapitalization is not generating any value for stockholders.

Ample liquidity and robust outlook
In spite of operating in an extremely competitive landscape, Apple has been doing very well due to its rapid pace of innovation. Apple recently signed up a number of big carriers including NTT Docomo in Japan, China Mobile and Russia's second biggest mobile phone operator, Megafon.

Under the just-concluded deal with Megafon, Apple signed a three-year deal to supply various models of iPhones. Apple had only 9% of the mobile units sold in Russia in 2013, according to Euroset, so unit sales should be growing in the Russian market. Apple's deal in Japan should also be very profitable for the company. The company has the highest segment operating margins from its Japanese operations, which amounted to more than 50% operating margins in fiscal 2013. 

The company's outlook remains very robust, with Apple expected to generate a ton of cash and have consensus earnings of close to $40 billion in the current fiscal year. Such excess liquidity in the company's balance sheet warrants the company to issue debt in the current low interest rate environment and take opportunistic advantage of the company's cheap valuation in the stock market. 

Icahn stated that his company upped its stake in Apple by buying $1 billion worth of Apple stock in the last two weeks, bringing his Apple stake to approximately $3.6 billion. Given Apple's tremendous borrowing ability, Apple should repurchase $50 billion worth of stock in fiscal 2014 by issuing additional debt.

Consumer loyalty
Apple has a been a leader in innovative consumer electronics products and managed to amass very high customer loyalty. This loyalty represents one of the company's greatest assets.

The company's brand value and global reach will ensure that future Apple products are well received not only in the U.S. but across the globe. The market for smartphones and tablets is expected to grow significantly in the next few years, and Apple along with Google  (NASDAQ: GOOGL  )  are well positioned to capitalize on this growth.

Samsung has made itself very dominant using Google's Andriod OS, but its focus has been mostly on the mid and low tiers of the consumer funnel. Apple's pricing and products are mostly directed toward higher end consumers. Its massive customer base of more than 575 million enables the company to charge much higher prices for its products relative to its competition. This allows it to maintain very strong gross margins to the tune of roughly 37%.

As consumers ramp up their software and service demands on Apple's App store and iTunes, customer loyalty will only increase and drive more value for Apple's earnings. 

Going forward
Apple has built up a massive ecosystem of software, hardware and services that gives the company a massive edge in launching newer products. Its huge customer base represents a major asset for the company. New product options including newer categories like TVs, wearable devices, and a payments platform are all realistic product lines for the company in the near future.

Because it features so much upside in its core business and a reasonably cheap stock, Apple should consider Carl Icahn's proposal. If the company's shares surge above $600, the value of the share repurchases will fall dramatically. As a result, the company should be more opportunistic in capitalizing on its undervalued stock now.

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