Michael Santoli

With Big Bond Sale, Apple No Longer ‘Thinks Different’

Michael Santoli

For years the most exceptional of corporate brand names, Apple Inc. (AAPL) is now the quintessential company of the current bull market, relying on the kindness of the bond market to fund an aggressive stock buyback. This maneuver is perfectly in sync with today’s financial-engineering fashion.

A year ago Apple stood astride the financial markets, attaining the highest market value ever as it topped $600 billion. The iJuggernaut’s fabulous profitability, stupendous share-price gains and cult-inspiring products nearly consumed all the capitalist oxygen in a world of muted economic growth, range-trapped stock indexes and plodding technological advances.

More than 90% of brokerage analysts were recommending the stock, it was the most heavily owned name by hedge funds and, at its $702 peak in September 2012, was up 70% for 2012 versus less than 15% for the other 499 stocks in the Standard & Poor’s 500 combined.

A well-known comeuppance

Then came the well-known comeuppance, with stiffer competition in mobile phones, disenchantment with Apple’s new-product slate and an inefficient balance sheet draining growth expectations from Apple shares, which have lost more than 35% of their value in seven months.

In response, Apple CEO Tim Cook and his board have acceded to the pleas of some on Wall Street to liberate some of the value of its huge but massively unproductive $140 billion in idle cash.

A regular dividend payer since a year ago, currently at an increased $12.20-per-share annual rate, Apple is now completing the largest corporate debt offering in history, tapping the pliant capital markets for $17 billion in debt at vanishingly low interest rates.

The cash raised will go toward Apple’s planned $60 billion share buyback over the next couple of years, which would fund the repurchase of 15% of the company from the public at the current stock price. Apple is tapping the debt market rather than repatriating cash it holds overseas, so as not to incur U.S. taxes.

A dominant trend

In this way, Apple has become the largest representative of a dominant trend in the corporate world. Large non-financial companies emerged from the economic crisis in better financial shape, with more cash and borrowing capacity than they needed for fresh capital investments. They have turned share buybacks into a core principle of their “shareholder value” efforts.

Total share buybacks by S&P 500 companies have approached $100 billion in each of the past three quarters, surpassed only by the excessive (and, in retrospect, ill-advised) buyback orgy of the third quarter of 2007, as the stock indexes reached their prior pre-meltdown peak.

Over the past four quarters, big companies used nearly 80% of their free cash flow to bid for their own stock. Meantime, companies have been supplementing their cash flows with ultra-cheap debt for corporate purposes, including buybacks. In the first quarter, companies sold $365 billion in new debt, says industry trade group SIFMA – on pace to match last year’s record total near $1.4 trillion.

The buyback binge has been an important, though probably under-appreciated, element of the stock market’s climb to new all-time highs early this year. Helped by the super-cheap cash sluicing through the capital markets, companies facing challenges boosting sales or cutting costs further are, in effect, taking themselves private in increments, thereby goosing per-share earnings by reducing shares in circulation.

A plus for stock performance

On a company-specific level, this activity has made stock performance look a lot better than the gain in overall corporate value. The stock price of AT&T Inc. (T), for instance, gained 17.5% from the end of first quarter 2012 through March 31 of this year. But because the company bought back nearly 7% of its share count over that span, AT&T’s market value rose just 9.3% over the same period.

So far this year and over the past 12 months, the TrimTabs Float Shrink exchange-traded fund (TTFS) – which owns shares of companies actively reducing their shares outstanding – has handily outperformed the broad market, proof that the market is, for now, rewarding such activity.

In Apple’s case, this sort of financial engineering makes sense on paper, largely because its cash hoard – growing fatter every day thanks to heavy cash flows – is essentially too big for any company to make use of intelligently through capital spending or acquisitions. The market would never fully “pay” for the cash through its market valuation, so kicking some back to investors with the help of painless borrowing is logical.

At some point, however, companies will prove to have paid too much for overvalued shares, and such paper shuffling won’t indefinitely obscure the reality that many companies don’t have enough organic growth or intrinsic value in their shares to satisfy investors.

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