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Does Apple Need More Cash Than You Think?

Evan Niu, CFA
February 27, 2013

The consensus among investors these days is that Apple (NASDAQ: AAPL) simply has too much money, and that it has no choice but to return more cash to shareholders as its coffers swell to unreasonable proportions. However, one analyst in particular is bucking the trend and argues that Apple actually needs more cash than most investors think.

Jefferies analyst Peter Misek recently downgraded his rating on Apple from "buy" to "hold" after the company's disappointing fiscal first quarter earnings release based on "real and material" iPhone growth deceleration and margin concerns, while noting that Apple's new approach to issuing guidance implies less upside. At the same time, he reduced his estimates and dropped his price target from $800 to $500.

Here comes your man
Misek is arguing that over the next two years, Apple has several major headwinds that have implications on its cash needs. The analyst thinks that Apple is looking at dramatic increases in capital expenditure requirements, which could potentially double. The company could also potentially face higher costs related to applications processors as well as increased content costs related to its rumored TV product. Apple also faces subsidy risks if carriers choose to abandon the subsidy model and consumers are faced with dramatically higher iPhone prices.

Let's dig into each of these points and see what implications they have on Apple's ability to increase its payout.

Cap ex facts
It's true that Apple's capital expenditures have risen dramatically in recent years, and it expects to spend $10 billion in fiscal 2013, including $850 million for retail stores. The majority of its capital expenditures nowadays are spent on beefing up supply chain capacity by purchasing product tooling and manufacturing equipment that resides in partner facilities overseas. Most of the remaining $9.15 billion of its forecast cap ex is expected to go toward this type of gear.

Apple has long been rumored to be switching to Taiwan Semiconductor (NYSE: TSM) to fabricate its A-chips as it continues to transition away from Samsung, and Misek doesn't believe that TSMC can independently fund manufacturing expansion to accommodate for Apple's possible business. Misek suggests that Apple may need to help cover some of these costs if it switches to TSMC. This is possible since TSMC's projected $9 billion in 2013 cap ex is smaller than Apple's cap ex budget this year. On the other hand, it's also been speculated that Intel (NASDAQ: INTC) has been seeking Apple's foundry business, and Chipzilla has very deep pockets and advanced fabrication plants where Apple may not have to foot as much of the bill.

Perhaps more importantly, all of the above cash requirements would primarily be overseas, where Apple has $94 billion stashed away. That manufacturing equipment sits in Asian factories belonging to Foxconn and other suppliers, and if Apple had to make a similar arrangement in helping TSMC build out capacity, that need could also be met with foreign cash.

Meanwhile, domestic cash is where dividends and buybacks come from, and assuming Apple isn't bringing that foreign cash home anytime soon, investors can think of them as two different pockets that Apple dips into for different needs.

On the subsidy model, Misek is missing the point. Risks related to Apple's reliance on carrier subsidies have been discussed at length for years, yet never materialized. For markets where carriers have adopted the subsidy model, there's simply no going back because consumers want more once they get a taste. This already played out in Spain, and is about to play out in the U.S.