Join        Login             Stock Quote

Why Apple Should Follow IBM's Successful Turnaround Story

 March 08, 2013 12:26 PM

In recent months, Apple's (Nasdaq: AAPL) CEO Tim Cook has repeatedly stressed that the company still has a number of aces up its sleeve. Cook has dropped coy hints that bold new products are in the pipeline, so Apple could still surprise investors with better-than-expected growth.

But even if Cook is right and Apple is on the cusp of an impressive product release cycle, then he's wrong on one key point: Apple will never again be a great growth story it once was.

The company's annual revenue base is fast-approaching the $200 billion mark, so even if the company is layered in tens of billions in new revenue, then that would only offset some of the revenue declines the Apple will experience from maturing key products and competitive pressure, which could lead to more price cuts.

[Related -Apple Inc. (AAPL): iPhone Trending into Another Carl Icahn Disappointment?]

Make no mistake, it is Cook's job to focus on product development and technology leadership. But Apple's board of directors now has a completely different task: Boost a stock price that remains in a free fall.

Luckily for Apple, another tech company once had the same image problem, yet managed to transition its message to investors successfully. "In 2005, IBM (NYSE: IBM) was telling the Street it could grow earnings double-digit, but the company was so complicated that analysts didn't believe it," wrote UBS analyst Steve Milunovich. He's actually been following technology stocks since 1997, and has seen a number of companies manage to reinvent themselves through changes in capital allocation.

[Related -Colgate-Palmolive (CL) Dividend Stock Analysis]

Milunovich draws parallels between IBM and Apple for a more prosaic reason: Both companies produce stunning amounts of free cash flow, thanks to returns on invested capital (ROIC) that exceed 30%. In fact, while IBM's free cash flow has remained fairly consistent in the past eight years, Apple's has been exploding.

Apple's Stunning Free Cash Flow

Milunovich says it's time for Apple to join an emerging trend among technology companies. "IBM was one of the early vendors to deal with maturity and make a strength of it by consistently giving back up to 80% of its free cash flow to investors," adding that "Intel (Nasdaq: INTC), Cisco Systems (Nasdaq: CSCO), and more recently Dell (Nasdaq: DELL) and Texas Instruments (NYSE: TI) have made strong commitments to returning cash."

Returning cash to shareholders is indeed a key reason why IBM's shares have always fared well, even when the broader tech sector has slipped out of favor. IBM has boosted its dividend by at least 13% for each of the past seven years, but the current yield is a fairly unimpressive 1.7%.

Yet Big Blue's retirement of more than 500 million shares is more impressive. That has enabled IBM to more than triple its earnings per share during that time frame, even as sales growth has never exceeded 8% in any given year. This has attracted mega-investors such as Warren Buffett, whose stake in IBM is now valued at more than $14 billion.

So with Apple's free cash flow set to exceed $40 billion in the current fiscal year, it's time to assess what Apple can do for shareholders. Let's assume, as Miluvonich notes IBM has done, that Apple earmarks 80% of free cash flow to dividends and buybacks, or $32 billion each year.

Allocating $8 billion each year to the dividend would translate into a roughly 2% dividend yield. Applying the remaining $24 billion into stock buybacks would shrink the share count by roughly 6% each year. Apple's board should actually show a great deal of flexibility on the matter. At times like this, when shares have fallen sharply in a short period of time, buybacks should be the main focus. When shares rebound (which they likely will if Apple pursues an IBM-style strategy), then dividend growth should be the focus.

In fact, you could take this concept a step further. With nearly $140 billion in cash in the bank, Apple could return 100% of its annual free cash flow to shareholders, and part with another $20 billion from its balance sheet each year. This works out to be $60 billion in play money, which could generate a 3% dividend yield and shrink the share count by 10% annually.

Risks to Consider: Buybacks can prove to be ill-timed if the market tumbles lower in subsequent quarters. Companies such as Nokia (NYSE: NOK) spent billions on buybacks, only to find they could have bought back a lot more shares a few years later when share prices were lower. That said, judging by the metric of free cash flow, Apple's stock is already close to washed out.

Action to Take --> Investors are clamoring for Apple to take bold action to boost its flagging stock. It should become increasingly clear to the company that promising a rebound in growth will not be the panacea for this stock.

If Apple decides to make bold moves such as big stock buybacks and dividend hikes, then shares could quickly regain altitude. Even in the absence of any near-term actions, shares look quite washed out at roughly 10 times free cash flow. This once-hot growth stock looks like a more compelling value stock with each passing day, making it safe to hop on board, even as others are heading for the exits.

-- David Sterman

David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of INTC, CSCO in one or more of its "real money" portfolios.


Post Comment -- Login is required to post message
Alert for new comments:
Your email:
Your Website:

rss feed

Latest Stories

article imageAutomating Ourselves To Unemployment

In this current era of central planning, malincentives abound. We raced to frack as fast we could for the read on...

article imageFed: Waiting For June… Or Godot?

The Federal Reserve left interest rates unchanged yesterday, as widely expected. But the possibility of a read on...

article imageThe Single Best Place To Invest Your Money For Retirement

It was never supposed to be this daunting. At least that's what we were read on...

article imageNegative Blowback From Negative Interest Rates

The Federal Reserve is widely expected to leave interest rates unchanged today. But perhaps standing pat read on...

Popular Articles

Daily Sector Scan
Partner Center

Fundamental data is provided by Zacks Investment Research, and Commentary, news and Press Releases provided by YellowBrix and Quotemedia.
All information provided "as is" for informational purposes only, not intended for trading purposes or advice. iStockAnalyst.com is not an investment adviser and does not provide, endorse or review any information or data contained herein.
The blog articles are opinions by respective blogger. By using this site you are agreeing to terms and conditions posted on respective bloggers' website.
The postings/comments on the site may or may not be from reliable sources. Neither iStockAnalyst nor any of its independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. You are solely responsible for the investment decisions made by you and the consequences resulting therefrom. By accessing the iStockAnalyst.com site, you agree not to redistribute the information found therein.
The sector scan is based on 15-30 minutes delayed data. The Pattern scan is based on EOD data.