Apple’s Buybacks: Still iDiotic

Last August during the China meltdown Apple CEO Tim Cook skirted SEC rules by sending an emailing to CNBC star Jim Cramer. The goal was reassuring investors.

 

Cook was talking his book. During the quarter ending September Apple spent $14 billion repurchasing its own shares at an average cost of $114. The company also completed a $6 billion “Accelerated Share Repurchase” last July, retiring 10m shares (listed below as part of a Q3 transaction but completed in July, per Cook himself during the Apple Q4 call).

During the last 3 months of 2015, in the quarter reported last night Apple bought $3b worht of stock on open market purchases at an average cost of just over $115 and yet another Accelerated Repurchase for $3b to get 20m shares on initial settlement. (For a good primer on why the average cost of accelerated repurchases is so much higher than open market transactions see this from the Motley Fool).

All of which would have been fantastic had Apple not discovered what the rest of the world already suspected: China isn’t great.

In his opening preamble Cook spent 2/3rds of the opening 750 words talking about currency, Chinese headwinds and the generally horrific turn the world has apparently taken since Cook emailed Cramer and launched an aggressive battle to protect Apple’s shareprice by throwing money at it.

“We’re seeing extreme conditions unlike anything we’ve experienced before just about everywhere we look” Cook said, all but ululating as he handed the media an almost perfect spotlight quote.

Cook went on to guide lower for the current quarter. Product shipments were a disaster on the iPad. Watch sales weren’t specifically disclosed (which means they are insignificant) and margins are a question. Currency alone swayed revenues enormously according to Apple itself. Those facts should pretty much eliminate the idea that companies in general, or at least Apple in particular, has a better guess than anyone else when it comes to their future results and share price.

Theoretical Cash

The company says it has $216 billion in cash but that’s misleading, to be nice.

Apple has about $16.5b in US cash, $53b in debt and another $35b in non-current liabilities. 93% of Apple’s cash is overseas and it currently costs 40% to repatriate foreign earnings.

How do you value all that foreign cash? You have to discount it dramatically. If you assume Apple repatriates the money at full tax rates (40%) Apple has an amount equal to $136b in real value. If you assume Apple can keep skirting the repatriation problem by borrowing cash in the US against the foreign cash of indeterminable value you have to discount the money for the interest paid, at the very least.

All of which ignores all that currency trouble Cook was nattering about last night. If Apple gets paid in China when does the money become dollars? What if cash flows drop? IBM once thought it had plenty of cash for buybacks. It spent a decade spending cash on shares and missing opportunities. Now IBM has neither the money nor the ability to execute.

None of this matters to buyback fanboys, the most vocal of which being Apple shareholders. Here’s AppleInsider’s take on buybacks from last October:

The key parts there are the assumption that both shares and earnings will rise. Also, Apple executives are uniquely positioned to “fully grasp the potential of the company in the global markets it is operating across.”

Everything about this is wrong.  More concerning still, Apple itself demonstrably has no grasp on what’s happening in China this year. Consensus estimates, the muddy bedrock on which buyback logic rests, are coming down as I type.

Rising debt, lower margins, uncertain earnings and a recent track record of buybacks utterly failing to help the shares. What’s the answer?

More buybacks, natch.

“We plan to be very active in the US and international debt markets in 2016 in order to fund our capital return activities.”

Selling Shares to the Least Efficient Buyer

Buybacks are the biggest scam since GreenMail. A company repurchasing shares is literally the least efficient buyer on earth. If you had $100 in cash yesterday you could have bought 1-share of Apple from me. Less the drag of transaction fees we would each still have about $100, or $200 total.

When Apple or other companies buy back stock they retire the shares. That’s the whole point. If Apple didn’t retire the stock the repurchased shares would drag on EPS. What’s more, the entire underlying assumption of buybacks is reducing shares outstanding will raise the price of the stock by an equal amount (which only makes sense if the market is efficient… and if the market is efficient there shouldn’t be “irrational” price drops in the first place).

The only buyer to get nothing out of Apple’s share appreciation since it launched its buyback program in 2013 is Apple itself.

The key to buybacks is that the shares outstanding disappear. So, unlike every other purchaser on earth Apple can’t practically sell shares purchased on the open market. Companies doing buybacks profit less than literally every other potential share holder when a stock rises.

If Apple buys my 1 share I then have $100 and Apple has 1 share which it immediately shreds. 50% of the total pie has been destroyed. Apple doesn’t get to count appreciation on repurchased stock. It means nothing to them. The cash and the stock are gone, all Apple has left are the interest payments. Just like John Law trying to stop the implosion of the Mississippi Bubble in 1720 Apple is effectively buying stock and lighting it on fire.

If the stock goes higher and earnings rise and cash flows stay robust that’s no problem. Should anything in that list not happen as expected the whole model falls apart immediately.

The Cult of Buybacks

I’ve harassed Apple on this point in the past and been shelled for it. I don’t care. Buybacks are a scam and I’m one of the few people who understands why and doesn’t have a financial interest in keeping it a secret.

History will be unkind to the capital allocations made by corporate America during the era of free rates. As usual, individuals are the sucker at the poker table with the Buffett’s and Icahn’s of the world.

Honestly, what would you expect?

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