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Why I'm Voting for Carl Icahn Over Apple, Inc.

As most Apple (NASDAQ: AAPL  ) shareholders know by now, Carl Icahn is in the building! The outspoken chairman of Icahn Enterprises has stated repeatedly that he believes Apple is extremely undervalued. On several occasions in the last six months, he has publicly demanded that the company return more cash to shareholders .

With Apple's annual shareholder meeting coming up in just a few weeks, Icahn has submitted an advisory proposal calling for Apple to buy back at least $50 billion of stock in its current fiscal year. Apple's board has recommended that shareholders vote against the proposal. Some other prominent investors, including the CalPERS pension fund, have publicly backed Apple's stance.

However, as an Apple shareholder, I'm siding with Icahn in this case. While I mistrust Icahn's motives, I agree with him that Apple is still holding too much cash on its balance sheet -- even after buying back $14 billion of its stock in the last two weeks! A bigger buyback would put dormant capital to work. It would also take advantage of Apple stock's recent pullback to shrink the share count at a relatively low price.

The latest proposal
Carl Icahn seems to have a bad habit of starting with a very big -- and somewhat unreasonable -- "ask" before retreating to a more defensible position. In this case, Icahn initially called for Apple to issue $150 billion in debt in order to fund a stock buyback of the same magnitude. After various iterations of that plan didn't go anywhere, Icahn eventually settled on the current proposal, which simply calls for a $50 billion buyback this year.

In arguing for the proposal, Icahn points out that Apple stock trades at a steep discount to the market, despite having better growth prospects than the average public company. He also notes that Apple has sufficient liquidity and borrowing power to devote $50 billion to buybacks this year without compromising its ability to invest in R&D or strategic acquisitions.

The counter-arguments
In its response to Icahn's proposal, Apple's Board states that the company already has a big share repurchase program in effect. It also claims the need to maintain sufficient resources to compete against other well-funded tech firms. Lastly, the Board notes that only domestic cash is available for distribution to shareholders, due to the high tax on repatriated foreign earnings.

Bearing all this in mind, the Board claims that it is speaking to a wide range of shareholders about potential changes to its capital allocation policy. Nevertheless, the Board argues that it (along with the management team) is in the best position to judge what Apple's capital needs are.

The case for a bigger buyback
As the owner of a tiny fraction of Apple's stock, I don't expect to be consulted directly by either Apple's Board or its management team on the company's capital allocation policy. Accordingly, I have decided that voting for Icahn's proposal is the best way for me to express my support for an even higher level of buyback activity.

I agree with Icahn -- and presumably Apple's management -- that Apple stock is significantly undervalued today. Buybacks are a great way for undervalued companies to build shareholder wealth. By reducing the number of shares outstanding, the buyback gives each remaining shareholder a bigger stake in the company.

Based on Apple's recent trading price, a $50 billion buyback would reduce Apple's share count by about 10%, which in turn would boost EPS by roughly 10% for any given level of net income. Over the course of a few years, buybacks at this level would cause a meaningful acceleration in EPS growth.

Apple would probably want to float another set of bonds to finance a buyback at this level. As of late December, the company had $158.8 billion of cash and investments on hand, but domestic cash only accounted for $34.4 billion of that total. After Apple's recent buyback activity and its upcoming dividend, the domestic cash pile could be as low as $20 billion.

I agree with Apple's management that it is prudent to keep a large domestic cash balance (at least $10 billion and perhaps even $20 billion) in order to maintain long-term flexibility.  However, that still should not pose an obstacle to a buyback, because issuing debt is so cheap right now!

Some investors would point to a recent warning from Moody's (NYSE: MCO  ) Investors Service that Apple would risk a credit downgrade if it adds more than $20 billion-$25 billion in debt in the next two years. That's not necessarily a good reason to shy away from issuing incremental debt, though.

For example, Hewlett-Packard (NYSE: HPQ  ) has a significantly worse credit profile than Apple . It was still able to issue 5-year fixed rate debt last month at an interest rate of just 2.75%! For Apple, maintaining an AA+ credit rating is probably not worth it when debt is that cheap for companies with lower investment-grade ratings.

Foolish bottom line
If Apple stock is indeed undervalued today, the company can capitalize on that opportunity by buying back stock at an even faster pace. Apple clearly has the financial resources to invest $50 billion or more in buybacks this year while still having the flexibility to spend as much as necessary for R&D, capital expenditures, and acquisitions.

While Apple has become better about distributing cash in the last two years, its efforts are still unsatisfactory. Since Apple announced plans to "return cash to shareholders" in March, 2012, its cash hoard (after subtracting its debt) has actually grown by more than $30 billion!

Even if Icahn's proposal passes, it's a non-binding vote; Apple would still be able to do whatever it wants with its cash. However, it's important for shareholders to send the message that Apple should be even more aggressive in putting its cash to work.

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Read/Post Comments (10) | Recommend This Article (2)

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 February 08, 2014, at 11:42 AM, DanManners wrote:

    If Apple believes it can grow earnings then it could have a whole lot more cash coming in. then it should do buybacks. But the p/e will just go lower. So if earnings grew to $ 80 per share, the EPS could go to 6. No guarantee the stock goes up. But you do save on paying out half the dividends if you ended up buying back half the original share count.

    I don't think Apple will succeed. The new things coming is a new color for the 5c? I don't think Cook can do it when he can't do maps or services very well.

  • Report this Comment On February 08, 2014, at 11:55 AM, jabstrat wrote:

    " Based on Apple's recent trading price, a $50 billion buyback would reduce Apple's share count by about 10%, which in turn would boost EPS by roughly 10% for any given level of net income. Over the course of a few years, buybacks at this level would cause a meaningful acceleration in EPS growth. ..."

    Of the several reasons AGAINST wasting billions on a share buyback, this is perhaps the most ridiculous of all. EVERYONE on the Street knows that artificially inflating the EPS with grade-school arithmetic 'tricks' bears no meaningful fruit. In fact, Q1's EPS was artificially inflated due to this, and the Street shot the stock down as a result (along with the huge miss on iphone unit sales.)

    Personally, i voted against Apple Management, but not because of any share buyback. Buybacks DON'T WORK, pure & simple. Apple as more than enough opportunities (IF they would only MOVE on them) to enhance their stock price, and their company's fortunes, without resorting to dinosaur-age company ploys such as buying back stock. (IF they were adept at this, they SHOULD HAVE put in this latest buyback at $390/share, not NOW.)

  • Report this Comment On February 08, 2014, at 12:20 PM, mshipe101 wrote:

    Apple has already committed $100 billion to be returned to investors via dividends and buy backs by the end of 2015. This is the largest commitment in history befitting people largest company in the world. I take issue with the recommendation that Apple should for more bonds to increase their buyback. Extending this logic to personal case, should you buy the largest house possible simply because mortgage rates are so low? Apple has steadily built billion dollar server farms in NC & NV with plans for ones in OR and AZ. Coupled with the manufacturing of Mac Pros in Austin and the $760 million investment in GTAT in AZ Apple's manufacturing presence has increased appreciably in the U.S. Furthermore, with Ahrens starting at Apple next month I believe there will be a multi billion investment in China and Japan not simply via retail stores but server farms as well. Thus, there are many investment opportunities that can easily require $5-10 billion. Yet they will still have $100 billion remaining given these considerations. Perhaps a better solution is that they agree to buy back stock each quarter if it is at reasonable cheap price to the extent that they still maintain a $20 billion cash reserve at which they presently reside. This provides and ongoing buy back plan yet maintains a safe haven of cash reserves for acquisitions or additional strategies.

  • Report this Comment On February 08, 2014, at 12:29 PM, larryw101 wrote:

    @Dan Manners,

    Your ever contrarian in bashing Apple will cost you dearly. I dare you to short it ! Your comments never have any merit and are getting as old as the ridiculous old picture next to your name.

    Please short Apple. But somehow I feel you're not that stupid.........or are you ?

  • Report this Comment On February 08, 2014, at 12:34 PM, midnightmoney wrote:

    I gotta agree with Jabstrat--if they were seasoned, they'd have been buying gobs of themselves way back at 390. On a related note, it makes me laugh to see headlines to the effect that GE is a buy now that it has pulled back from 26 to 25, a minor move akin to apple's. The time to be buying the latter's was when it was truly down, at 15 a share two years ago. But the press wheels must turn to attract the advertising bucks backing sites dedicated to covering the stock market, so the headlines and the advice cannot and will not stop flying.

  • Report this Comment On February 08, 2014, at 12:35 PM, mshipe101 wrote:

    @jabstart Please shoe me a DCF model that does not include outstanding shares. If Apple has artificially increased EPS via share buy backs then the converse in also true. Every stock option issued artificially dilutes EPS yet that isn't discussed nor is it any more logical. Stock buy backs strengthen the effect of net income growth in then future, especially of that growth is significant. I am unable to find a company who yields more cash, holds the promise of future innovative products and enjoys brand recognition to the extent that Apple does. Thus, I do not fault them for engaging in the largest acquisition ever - themselves. You might consider that if Apple ceases to not grow for the next 10 years and sustains it's buy back policy, it can go private. And if you don't think the outstanding float influences the stock price of a company beyond valuation metrics then simply look at GOOG and PCLN and how there valuation has radically changed. Yes, they have demonstrated remarkable growth but Apple grew revenues from 21-81% for 9 consecutive quarters with a P/E of less than 20. The effectiveness of Apple's buy back will take years to determine and you can happily vote against it by not buying the stock.

  • Report this Comment On February 08, 2014, at 12:39 PM, MellowGuy1 wrote:

    AAPL could buy ORCL for about $150 billion. That would be a much better move than a stock buyback.

  • Report this Comment On February 08, 2014, at 12:49 PM, ranchrfl wrote:

    My wife and I gave Icahn our votes not so much because we want to see a bigger buyback but because we believe more needs to be returned to shareholders in the form of dividends.

    Our shares are in Roth IRAs and we are retired give us the cash. Spending cash is better than spending shares and we would think many retirees would rather AAPL give them cash than make them sell shares to get to the same point.

    It's not rocket science.

  • Report this Comment On February 08, 2014, at 1:43 PM, tkell31 wrote:

    They still have $33 billion they can raise in debt from the plan last year, but "only" 18 billion left of the 60 allocated to buybacks so something has to give. My guess is in March they announce an increase in the buyback portion of the equity return from 60 to 100 billion and raise from 17-33 billion through a bond offering to help pay for the 40 billion increase.

    Would the be good for the stock price? Sure it might result in a 10% increase, but I doubt it will have much more impact since everyone understands it's just financial manipulation, not growth. Plus as big as 100 billion is they've already spent close to half of it and an additional 12-13% reduction in the float from here isn't that exciting. I think Ichan realizes that which is why he called for $150 billion more…that would enough to force the stock to go significantly higher or sit at a 7-8 PE.

    Almost four years since the iPad came out. One of the biggest companies in the world and they can't come up with more than one new product every three - four years?

  • Report this Comment On February 08, 2014, at 3:23 PM, TMFGemHunter wrote:

    Thanks for the comments, everybody.

    You can call buybacks a "trick", but personally, I consider it a "treat"! Buffett has selectively used buybacks as a key tool to increase the value of Berkshire Hathaway shares. It's hard to argue that he's been unsuccessful.

    I think the anti-buyback fervor is driven by the short-term mentality that seems to drive most Apple commentary. The past couple of weeks of buybacks will have a limited impact on Apple's long-term stock performance. A difference in EPS of a few percent one way or the other can easily be offset by multiple expansion/contraction.

    However, a long-term policy of buying back a lot of stock when it seems cheap compared to current earnings and future prospects can add a lot of value. Even if Apple's net income grows at a low-mid single digit rate, buying back at least 10% of the shares annually can drive sustainable double digit EPS growth. If you want a real-life example, look at dept. stores like Macy's and Dillard's.

    A few years of double digit EPS growth would naturally lead to significant share price appreciation. (The slower the stock price goes up in response to buybacks, the cheaper and more effective future buybacks are; as long as net income stays steady or increases, there's not much downside.)

    BTW, for those of you criticizing Apple's timing, Apple's biggest buyback occurred last April, when the stock dropped below $400. I believe the company put $16 billion into buybacks at that time.


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Adam Levine-Weinberg

Adam Levine-Weinberg is a senior Industrials/Consumer Goods specialist with The Motley Fool. He is an avid stock-market watcher and a value investor at heart. He primarily covers airline, auto, retail, and tech stocks. Follow him on Twitter for the latest news and commentary on the airline industry!

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