Apple 2.0

Covering the business that Steve Jobs built

Apple's $24.5 billion: The case for a big stock buyback

October 29, 2008: 12:13 PM ET

Here's a headache most companies would love to have.

Apple is sitting on a huge cash reserve -- $24.5 billion as of September and growing at the rate of $8 to $10 billion a year --  that's doing almost nothing for it.

The money is earning about $1.55% interest after taxes, according to a report issued Wednesday by Bernstein Research's Toni Sacconaghi, at a time when the company's stock is trading at a unusually low (for Apple) multiple of 15 times earnings.

That makes conditions ideal for a massive buyback of Apple (AAPL) shares, says Sacconaghi.

"Mathematically," he wrote "share buybacks boost EPS only if a stock's P/E multiple is lower than the reciprocal of the after-tax interest rate earned on cash."

Apple has been trading at 30 to 40 times earnings in recent years, which Sacconaghi believes is one reason Apple has not initiated a stock repurchase program in the past 5 years.

But today, according to Sacconaghi's model, Apple is trading at about 18 times his fiscal year 2009 earnings estimate (and about 13 times earnings using non-GAAP numbers). By his formula

18 < 1/.0155 < 64.5

Sacconaghi goes on to calculate what a buyback would do to Apple's share price. Ten billion dollars spent purchasing Apple share, he estimates, would boost the company's (GAAP) EPS about 4%. A $20 billion buyback program would boost it about 9%. And if the $20 billion program were front-loaded -- completed in the first fiscal quarter of 2009 -- the company's EPS could jump as much as 15% (or $0.75 a share).

Heady stuff for shareholders. And, according to Sacconaghi, better than the alternatives: making a major acquisition, paying a substantial dividend or continuing to let its cash hoard grow -- which might make it a tempting target for corporate raiders who see the cash as a way to pay for a hostile takeover.

A big dividend -- say, 5% -- would consume only about half Apple's cash flow, and a special dividend would dilute Apple's earnings growth too much to please shareholders.

A major acquisition is another possibility, but it would be out of character for Apple. The company usually buys small shops that it can bend to its will, and there aren't many big ones out there that can keep up with Apple's blistering pace of innovation.

Of course, Steve Jobs may have better ideas than Toni Sacconaghi about what $25 billion can do. The last time Apple's stock fell this sharply -- plunging from nearly $40 a share in March 2000 to $7.44 in December 2000 --  Jobs used the cash he had on hand to start a chain of Apple Stores.

[Chart courtesy of Bernstein Research.]

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About This Author
Philip Elmer-Dewitt
Philip Elmer-DeWitt
Editor, Apple 2.0, Fortune

Philip Elmer-DeWitt has been following Apple since 1982, first for Time Magazine, and now on the Web for Fortune.com.

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