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An Apple Dividend Could Lure Warren Buffett Into The Stock

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This article is more than 10 years old.

A few months ago I put up a post detailing Warren Buffett's affinity for holding stocks that pay dividends (please read "Berkshire Hathaway's Dividend Obsession"). I wrote the article just after it was announced that Buffett was buying into IBM and Intel, two technology companies. Longtime Buffett followers and the media noted that Buffett has tended to shy away from technology stocks or "things he didn't fully understand" and that this was a marked change in strategy. It really wasn't. Buffett loves companies that have strong business models, with an ample moat protecting them, plus he likes companies with rock solid corporate cultures, bigger than any one CEO. You don't see "superstar, iconic CEO's" in Berkshire's portfolio.

With Steve Jobs no longer running Apple, the whole cult of the CEO thing is over, and Apple is charged with proving that its corporate strategy and culture supersede any one leadership figure.  Buffett's recent big purchase, IBM fits these characteristics as do other Berkshire holdings ranging from Wells Fargo to Coca Cola and American Express.

So why not add Apple to Berkshire's portfolio?   I recently asked Paul McWilliams, editor of technology investing newsletter Next Inning Research, what he thought about a potential Apple dividend and whether the company might fit Buffett's rigorous criteria. After all quite a few professional value investors have noted that cash rich, modest -multiple Apple is a value stock, including John Buckingham, editor of The Prudent Speculator and Jim Kieffer value manager at Artisan Funds. Kieffer was named domestic stock picker of the year in 2011 by Morningstar and he holds a boatload of Apple in his Artisan Value Fund. You should also note that a number of smart value hedge fund managers including David Einhorn of Greenlight Capital, are big holders of Apple's stock.

Here is what McWilliams had to say today:

"What Buffett is finally seeing in Intel is precisely what I've been writing about for a very long time. Within months of Otellini's appointing as CEO that his first mission was to change the culture and the operating model . At this juncture, the odds of INTC's franchise value being disrupted by competition are lower than the odds AAPL faces." He went on. "That said, if AAPL were to reduce the cash hoard by paying a one time dividend of $50, which would still leave it with $50B, and institute a ~3% annual dividend on what would then be a lower price (the stock would drop an amount roughly equal to the one time dividend), it would almost certainly attract dividend investors and move up on Buffett's radar screen."

Below are some of McWilliams comments on Apple's cash hoard, which may soon hit $100 billion. The excerpt is taken from his newsletter's State of Technology Report: Ecosystem Companies, which was published on January 23, 2011 when Apple's shares were priced at $420. At the end of this excerpt please note that his target price at the time was "$495 to$574."

McWilliams:

With over $81B in net cash and long-term investments, the list of companies AAPL could buy without taking on a penny of debt is long and impressive. That’s up from only about $4B in net cash only 10 years ago. To put this in perspective, the combined market capitalization for Dell (DELL) and HPQ is only $86B – AAPL has nearly that much in cold hard cash.

However, when contemplating anything beyond a simple bolt-on acquisition AAPL has to consider three things beyond the basics every company must evaluate when thinking about making an acquisition.

1. AAPL has a homogenous ecosystem that it has driven to a common operating system. That is what makes the whole much more valuable than the parts. Anything AAPL acquires will have to be something it can drive into the ecosystem. This makes it pretty difficult to acquire any major consumer brand.

2. AAPL is not in the business of selling intermediate goods or components to Original Equipment Manufacturers (OEM). In other words, I don’t see AAPL buying a semiconductor company or anything else that sells unfinished goods, or even intellectual property, to other companies. That simply doesn’t fit the AAPL model. If AAPL chose that tact, I would worry about it.

3. If AAPL were to propose a major acquisition that would increase the strength of its Ecosystem it would draw the rapid and likely harsh scrutiny of regulators around the world. Even if that didn’t end up blocking the deal, AAPL would be drawn under the regulatory microscope and I don’t think that is something AAPL wants to risk at this juncture.

When it comes to large potential acquisitions I think AAPL would have an interest in acquiring a company with significant exposure to media creation and/or media delivery. Along these lines, a company like Comcast (CMCSA) would seem to make sense and may not immediately raise the hackles of regulators. However, I’m not suggesting that is what we should expect. What I expect are further bolt on acquisitions like we saw last year with Anobit.

Anobit was an innovative privately held Israeli company that offered AAPL a solution to two strategic goals. First, AAPL will leverage Anobit’s NAND Flash management technology to allow it to use “raw” versus “managed” NAND Flash for storage. NAND Flash is a commodity and, as such, is not a market AAPL should have any interest in entering directly even though it is currently the largest buyer of NAND Flash in the world. However, the management and control of NAND Flash offers many opportunities for differentiation and, in AAPL’s case, an ability to use simple raw NAND Flash that is cheaper than using managed NAND Flash.

An example of how AAPL will deploy this strategy can be seen in AAPL’s MacBook Air where NAND Flash is simply laid out on the PC board like any other chip and managed to look as though it is a hard disk drive. The second advantage AAPL realized through this acquisition was a very solid base of engineering and management talent it could use to open its Israeli R&D effort. To read more about the Anobit acquisition, please see our special report that was published prior to its official announcement.

Given the above points, and the fact AAPL is very well positioned to generate continued organic growth and enter a number of new markets on its own, I think its stash of cash is doing it more harm than good. Due to the fact AAPL’s cash is responsible for more than 20% of its market capitalization, it could step out of the headlines for a while by paying out a nice one-time dividend. Heck, AAPL could easily pay a one-time dividend of $50 per share and still have over $30B in net cash. That would bring AAPL’s stock price and market cap down some, and possibly delay regulatory scrutiny as AAPL moves past XOM to secure its position as the most highly valued company in the world. An alternative, or a strategy that AAPL could execute in conjunction with the onetime dividend, would be an ongoing dividend of say about $12 to $15 on an annual basis - that could be easily managed by AAPL’s rich free cash flow.

Balance Sheet: As noted above, AAPL carries a monstrous balance sheet with Net Current Asset Value of $70.92 per fully diluted share and a net cash value of $81B, or $86.82 per fully diluted share. Please note that both include $55.6B in long-term investments valued at $59.20 per fully diluted share. Net Current Assets are adjusted for $5.8B in deferred revenue liabilities valued at $6.15 per fully diluted share.

The primary offsets between NCA and Net Cash include $0.76B in inventory ($0.86 per share) and a negative balance between accounts payable and receivable of -$10.1B (-$10.80 per share) – AAPL is very good at using other people’s money for its working capital. Balance sheet line items described simply as “other” current assets, or other total liabilities, make up the balance of the difference. Due to the fact AAPL’s inventory is pretty much golden beyond any adjustments it might make as it transitions to new models, I’m going to factor inventory down by $0.07 (gives me a round number), resulting in an estimated balance sheet value of $70.85 per fully diluted share.

Valuation: In our last State of Tech report I forecasted AAPL’s fiscal 2012 earnings would be reported in a range running from $33 to $38 (midpoint $35.50). At the time the consensus was only $32.49. As of this morning that consensus has moved up to $35.35 – only $0.15 below the midpoint of my October forecast range. Given the resounding success we’ve seen from the iPhone 4S, which has been above even my optimistic projections, I raising my forecast range to run from $34 to $38, which provides a midpoint of $36.

If we base our model on a range of projections running from the $35.35 consensus to the $36.00 midpoint of my forecast range, use a range of valuation multiples running from 12 to 14, and add to the results my estimated balance sheet value of $70.85, the resulting three to six month price target range runs from $495.05 to $574.85.

[Full disclosure: I have been long Apple for many years and continue to hold it in my portfolio. Paul McWilliams is also long Apple.]

For more information from Paul McWilliam's Next Inning Technology Research, including his State of Tech reports, click here.