Why Apple Inc. (AAPL) Should Use Debt to Finance a Larger Buyback

Increase or a One-Time Dividend?

To decide whether this is a good option for shareholders, you must take a step back. Obviously, a shareholder purchases Apple not for the return on cash, but for the return Apple generates as a company. However, if a company is reluctant to return cash to shareholders, why not roll with what the casino gives you? Most portfolios out there will have some allocation to short-term, ‘safe’, assets. When you purchase $10,000 of Apple, you are really purchasing about $7,500 of Apple and $2,500 (net of taxes) of short-term assets. Now, I am not exactly trained on the policy of compounding IRS tax deferred bills, but if Apple is earning 1% on their tax-deferred cash balance, they are in effect deferring taxes for you. So, why not allocate your portfolio according to what your investments truly are and use the tax advantage.

Another common argument for dividends goes something like this: it attracts a new group of shareholders because of a higher yield, which will subsequently increase the price of the stock. If there is a higher demand for the stock because a new group of investors become buyers the stock price may go up. However, it is important to note that the supply/demand for a stock does not implicitly affect the true value of the stock based on its earnings. This potential higher stock price is a one-time action, and future shareholders will not benefit from this one-time action.

Stock-buybacks:

Currently, Apple is trading at around 7x earnings ex-cash. I believe a share buyback would be the best long-term option for Apple shareholders, which is the investor base Apple should currently be considering. A buyback would allow shareholders to benefit from the low valuation on Apple stock. If the Board of Directors believes that Apple will at least maintain earnings, it would be a mistake for them not to buyback shares at these levels. From a cash flow perspective, buybacks allow a company to either increase its dividends or lower their overall dividend obligation due to lower shares outstanding.

Most arguments against buybacks center around the idea that in the past, managers have not bought back their shares at opportune times. It is hard to argue this is not an opportune time for share buybacks given the low price to earnings ratio.

So…Debt Financed Buybacks?

Apple would not be new to this concept. Microsoft Corporation (NASDAQ:MSFT) , Oracle and Cisco have issued large amounts of debt despite their large offshore cash balances. All have been buying back stock with some of these proceeds. A lot of people point to Microsoft’s buyback program claiming that the stock price hasn’t moved. Well, we are only seeing the stock price outcome as the result of this decision to buy-back shares. What would Microsoft be trading at if they had not bought back billions in stock? Also, Microsoft is not Apple and to compare the potential outcome of an Apple buyback with another company’s past buyback is not a fair comparison.