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Apple: Value Creation and Stock Splits

Monday - 7/1/2013, 1:05pm  ET

With the stock price of Apple  below the $400 mark, the company can take a few steps to create value for its shareholders. Apple is being rather tight-lipped about its next line of new and innovative products, mainly for strategic and competitive reasons. However, the company can take more solid steps to expedite its value creation as its stock price is at 52-week lows. Apple can step up its share repurchase program to actually create value, and simultaneously consider a stock split to make the most out of ongoing investor pessimism.  

Valuation is cheap

With Apple's stock price below $394 the company's dividend looks very attractive for yield-seeking investors, while simultaneously waiting for decent capital gains in the medium term. Apple is trading at a decent discount to its true intrinsic value under any valuation method. Apple has a trailing twelve month P/E of 9.4, and a forward P/E of 9. And Apple has an Enterprise Value of roughly $242 billion, after adjusting for its total cash position of $145 billion and the recent $17 billion debt issuance. 

Owing to the massive success of the iPhone and iPad product lines, Apple's cash balance has seen dramatic increases every quarter. The company now has cash per share of roughly $152, which protects a sizable portion of the downside risk of investing in Apple shares at current prices. And at such an attractive market price, the company should take strides to accelerate its share repurchases. Apple has an authorization of repurchasing up to $60 billion worth of stock and the company should take steps to expedite that process. 

Share repurchase hasn't done well 

Often times the management of a company repurchase shares at very high market prices which negatively impacts their cash cushion for the future. Apple's stock has been trending downwards in the last one year, and as a result, the company's share repurchases have been very ill-timed. So far, Apple has bought back 4.08 million shares utilizing $1.95 billion of cash at an average repurchase price of $478.20.

Since the company's shares have dipped below $400 recently, the share repurchase hasn't added any value to the company's existing stockholders and would have been better off sitting in Apple's balance sheet. But at current prices the company should use multiple banks and brokers to really ramp up its share repurchase, which if executed properly, can add solid value for shareholders in the long-run. If Apple can retire a sizable number of shares from the open market, it will give the company's earnings per share a sizable boost.

On the contrary, numerous companies have done a fantastic job of creating value for shareholders like Time Warner . The media and entertainment empire of Time Warner generates a steady stream of revenue and cash flow, and has done a commendable job of executing a share repurchase program that benefits shareholders. Time Warner's board green-lighted a share repurchases of up to $4.0 billion in Jan-2013, and the company did a great job buying back 12 million shares for $660 million at an average price of $53.61.

Time Warner's stock price is trading above $57, as a result, the share repurchase has been beneficial for shareholders in driving the value of the company. However, the same thing cannot be said for Apple.

The case for a stock split

Apple had three 2-for-1 stock splits in its operating history and the last one took place in Feb-2005. Even though the markets are largely dictated by the moves of the large institutional investors, the small investors and big investors love stock splits. Stock splits give investors a psychological boost, as they own more shares of a company. 

And if Apple can pull off another 2-for-1 or 3-for-1 split in the near-term after conducting a sizable share repurchase, the company's market cap in the equity markets could get a boost. Apple's management had previously stated that they have evaluated the possibilities of a stock split, but haven't taken that course. However, they haven't ruled out a stock split in the future. 

Even though stock splits don't create any real value or have a material impact on a company's business, stock splits do lead to a much wider and broader investor base, which leads to higher demand/supply of shares in the open market.  Apple can possibly increase its market cap from existing levels, if the company's management decides to split the stock. 

Value creation

If a company has ample cash in hand and its shares are undervalued significantly from its intrinsic value, a buyback represents a great investment from the company's standpoint. In my view, if Apple makes a sizable repurchase at the current going prices of $400, the company can generate value for its shareholders. And after that, if the company can execute a 2-for-1 or even a 3-for-1 stock split the company can extract a lot of value from the equity markets.

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