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John Engle
John Engle
Articles (256) 

Apple Earnings: The Cash Pile Keeps Growing

Now the question is what to do with it

January 30, 2019 | About:

Apple Inc. (NASDAQ:AAPL) reported first-quarter 2019 earnings after hours on Jan. 29. Shares had taken a tumble at the start of the year after the company announced a profit warning, revising guidance downward based on evidence of softening demand for its iPhone smartphones. The latest earnings report added further color to these woes, including a precipitous drop in year-over-year sales in China.

But all was not sturm und drang in the company's latest earnings. When it comes to cash, Apple is still the king: Its cash pile has grown to a whopping $245 billion as of the end of the quarter, up from $237.1 billion three months prior.

We are left with a big question: What is Apple going to do with all that cash?

We’ll always have buybacks (or dividends)

One obvious option is to increase share buybacks. Having increased its cash balance by nearly $8 billion even as it engaged in one of the biggest buyback campaigns in corporate history speaks volumes about the remarkable cash-printing machine Apple has built.

Apple spent years refusing to return cash to shareholders through buybacks or dividends, but activist investors eventually prevailed on the company to hand over a big chunk of its hoard. While Apple was reticent at first to part with a single coin, it has since embraced buybacks with great enthusiasm. Over the first three quarters of 2018, Apple bought back just shy of $63 billion worth of shares, reducing the share count by nearly 7%.

Buybacks, though, have not been Apple’s friend of late. Despite its buyback binge last year, the stock price still slid. A December Wall Street Journal report highlighted this issue:

“Like many large companies, Apple has used much of its windfall from the 2017 tax overhaul to buy back shares. But the recent plunge in stock prices has made that look like a bad idea ... In effect, the market has told them they overpaid by billions of dollars.”

Apple does not appear to have been dissuaded from the buyback approach, despite the lack of credit it is getting from the market in recent months. Perhaps, as we opined in a recent research note, the company might consider an alternative approach, such as issuing a dividend.

In any event, whatever else Apple does with its cash, buybacks in one form or another seem likely to continue for a while yet.

Apple Capital keeps growing

As we discussed in a research note last February, Apple’s cash-generating machine has resulted in the creation of a huge financial arm. Indeed, this “Apple Capital” (as it has been dubbed by The Economist), is of comparable size to any bulge-bracket investment bank. With more than $260 billion in assets, as well as more than $100 billion in debt, Apple Capital is a huge financial vehicle, yet it still gets little attention from investors.

Part of the lack of attention to Apple’s financial operations is the result of the fact that it does not exist per se, but is rather a term used to describe a number of disparate vehicles. Chief among these is Braeburn Capital, which is responsible for much of Apple’s investment allocation decisions.

On the surface, Apple’s investment activities seem innocuous enough, with Braeburn et al. putting the tech giant’s capital into relatively safe securities for the most part. Yet, Apple has also shown a growing appetite for risk. The company has been increasingly involved in derivatives (albeit principally to hedge against currency and interest rate risks), and it has issued billions of dollars worth of floating-rate bonds.

If Apple continues to grow its financial arm, it could prove a lucrative venture. Yet, the lessons of the past offer a stern warning. History is strewn with stark examples of operating companies’ financial arms running amok. GE Capital (NYSE:GE) springs to mind.

Apple must be very cautious not to expose itself to risks it does not fully understand and that could undermine its core business. Its cash hoard would probably be better spent elsewhere.

The siren song of M&A

Apple has one of the largest stores of dry powder out there. But it has been reticent to use it. A slowdown in Apple’s core business could make the growth expected by investors (expectations that are reflected in its share price) difficult to achieve through organic processes alone. Hence, acquiring other businesses may prove an enticing path forward for the tech giant.

Acquisitions have never really been part of Apple’s DNA as a company. Its biggest ever acquisition was in 2014, when it bought Beats Electronics for $4 billion. That has not stopped Cook from playing with the idea of acquisitions over the years, however. Back in 2013, he opined that Apple had been exploring major buyout opportunities. In 2016, Cook again raised the notion, declaring that Apple was “open to acquisitions of any size.”

Nothing much has come of Cook’s “openness” to buyout opportunities in recent years, but the signs of slowing in its core business may at last turn exploration into action. That said, few Wall Street analysts expect Apple to do an about-face overnight, though many think the company might pursue a greater number of accretive acquisitions going forward.

What Apple might buy is anyone’s guess. And it may opt to stay the course despite the slowdown in sales. There is some sense in that. Acquisitions may seem accretive, but often prove costly. A lack of discipline in mergers and acquisitions has resulted in the implosion of more than one cash-rich enterprise. Apple, with its long history of extreme discipline in that arena, is not likely to go overboard, but any signal its strategy is evolving could trigger a negative market reaction as investors might begin to question the company's growth narrative (and that narrative’s attendant high valuation).

Verdict

While Apple will be faced with a host of questions in the coming months, the question of its cash on hand is particularly intriguing. While operational questions are important (operations are what built - and continue to increase - the cash hoard, after all), they are fundamentally evolutionary in nature. A change of strategy, especially if it involves expanding capabilities through mergers and acquisitions, would signal a revolutionary change.

Whether it chooses to continue adding to its hoard, engage in more buybacks (or dividends), go on a buying spree or something else entirely will shape the future trajectory of the company. It would likely have considerable implications for the wider market as well, given Apple’s position near the apex of publicly traded companies.

Cash is king at Apple, as with any company. So, whatever Apple decides to do, we (and the whole market) will be watching closely.

Disclosure: No positions.

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About the author:

John Engle
John Engle is president of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

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