Apple is sitting on the largest cash hoard of any publicly-traded company, or any company for that matter. It has $137B in its coffers and, based upon its current trajectory, Apple could have over $170B in cash, short-term and long-term investments by then end of the year. Analysts, investors and reporters were in ‘awe’ of the cash flow as the company’s stock appreciated from $7 to $700. Now, with Apple trading in the mid-$400s, the ‘awe’ has turned into ‘ire’ and for good reason.
(When “cash balance” is referred to in this article, it means cash, short-term and long-term investments.)
David Einhorn pushed the large cash issue as far as he could. David is a successful investor, with a strong track record. He is renown for his thoroughness. From David’s point of view and as representative of shareholders generally, he could put the cash balance to better use (read: better return) if he invested it rather than Apple just sitting on it. If the cash were returned to investors, they could decided how they wanted to invest that cash, ie conservatively or aggressively, as they wish rather than putting their faith into Apple to run this very large portfolio.
The overall size of the portfolio is enormous. To put Apple’s investment portfolio in perspective, consider this. Bridgewater Associates is the largest hedge fund in the world and is estimated to manage between $120 and $145 Billion in assets. This suggests that Apple is either the largest or second largest hedge fund in the world, with tremendous investment return potential. Yet, approximately $40B of the $137B is in ‘Cash and Short-Term investments’ which investors know painfully well yields barely any return at all. And shareholders are not even privy to the investment strategy of the remaining almost $100B. Shareholders of Apple are, in effect, investors in the largest hedge fund in the world with absolutely no idea what they are invested in.
The real question is how to make money from that cash balance. In theory, investors want companies to invest their cash back into building their businesses. Hence, no one cared about the cash in the stock-price march from $7 to $700 because Apple was apparently making it “work” for shareholders. As Apple’s stock faltered (or, more appropriately put, took a skydive), shareholders began to want to put the cash to work themselves, because investors could certainly return better than -35%, if they invested it themselves, or so the theory goes. There’s another answer, however.
Innovate. Keep the cash and use the cash and innovate. And innovate now.
Apple is the innovator for consumer technology. Apple is the company that made consumers have to have iPods, iPhones, and iPads. Apple was not the very first to introduce a music player, smartphone or tablet, but it has been the first to mass-popularize each. Apple wasn’t first because it didn’t introduce products until the technology could realize Apple’s vision of how the product should work and what the consumer experience should be. And in doing so, Apple paved the way for competitors to have success in Apple’s wake. Disruptive innovation is Apple’s hallmark. It is time for another disruptive product and it is certain that Steve Jobs left that playbook for Apple.
Apple has a large talent pool from which to drive innovation and a roadmap or culture on how to bring innovation to market. And Apple has this enormous cash balance to fund this talented pool of designers, engineers and marketers to introduce new products to market. So, in a way, owning Apple could be like owning part of an incubator, if it innovates, and that could be very exciting for shareholders. Then Apple can leverage its brand promise to create shine on any new product. Apple’s brand promise to consumers is a delightful user experience, and nothing during the period of the stock demise has changed the brand promise.
It is anticipated that Apple will introduce an iWatch this year and an iTelevision next year. Both have the potential to be disruptive. The iWatch is speculated to be able to provide alert messages such as texts, emails or incoming calls, be a music player, provide medical information such as heart rate, and utilize GPS such as running routes. It’s wearable technology. That’s disruptive. The success of the Pebble watch evidences demand for such a device. The Pebble watch was one of five new technologies that the Financial Times highlighted out of CES in January.
The iTelevision, with a iOS interface, also has the potential to be disruptive, only if Apple introduces it soon, before Samsung and others beat Apple to the punch. Apparently the gating factor for an iTelevision introduction as put forth by analysts is the expense involved. Estimates abound by analysts that Apple will need to increase research and development spending substantially over the next several quarters in order to introduce the iWatch and the iTelevision, creating worries that R&D will eat into the cash stash and margins.
Are compressed margins for the investment in new products a bad thing? Some analysts correlate Apple’s stock price to its margins. However, I’m not sure that is correct. The stock case for this resides in Amazon, which is continually investing in distribution centers, new products and its Amazon Web Services platform to the detriment of margins, and shareholders just keep paying 71.6 times forward earnings. Apple is a serious laggard in terms of R&D spending amongst technology companies. Currently, Apple ranks dead last in its R&D spending at a percent of sales. In this last reported quarter, R&D was 2.1% of revenues, compared to 13.6% for Google and 13.3% for Microsoft. To reiterate, even Microsoft, who has been left for dead, is investing in R&D, and Google, who most see as Apple’s arch nemesis, is outspending Apple by over 1,000 basis points. At both end of the spectrum, competitors are investing in the future. What is Apple doing?
Apple should use its cash to leverage its talent pool and assets to bring new products to market that will, in turn, increase revenues and profitability over the long run. Invest in the future. Don’t manage the company for short-term profitability but rather for long-term genius and sustainability. If Apple had nothing in its sights in terms of innovation or new products, it should return the cash to shareholders. But if Apple, as suggested, is moving toward an iWatch or iTelevision, it needs to increase R&D investment and accelerate the process. Investors should be ecstatic with short-term margin compression with R&D investment, because it would signal Apple’s commitment to innovation. The cash balance isn’t an issue if Apple uses it to innovate.
And, if Apple really wants to make shareholders happy, spend the cash to innovate and split the stock.
