Archive for the ‘Market Observations’ category

Apple (AAPL) and its Cash

May 5th, 2010

What do you do when you have $50bn. in loose change in your pockets? This is the dilemma Apple Computer will be facing by the end of its fiscal year. And that may be conservative given Apple’s cash hoard has already risen by $ 10bn. since the end of September.

With its only debt related to lease obligations, Apple has been as big a cash machine as their exists in the US financial marketplace.

Financial theory posits a company that continues to watch its excess cash rise, to the point it is greater than its shareholder’s equity, with no debt other than a reasonable lease structure, would be frowned upon by investors. It is expected such an entity should either return that cash to shareholders in the form of dividends or share buybacks, re-invest back into the business, or to make acquisitions above its weighted average cost of capital.

Apple, however, is an exception to financial theory. They have been so adept at using other firms’ capital, there is really no need, at this time to spend more within, than they are already doing. From their supply chain to their marketing and R&D, Apple is unparalleled.

As Steve Jobs and the board of directors at Apple have so far shown no inclination to pay a dividend or buy back stock, the only remaining outlet for that continuing cash rise is a large acquisition.
And there, the universe is extremely limited, baring a large number of small acquisitions, which Apple can do anyway.

Under a reasonable scenario, Apple management would most likely only approve a large business combination meeting all of the following criteria:

1-Size of Deal- Not greater than $100bn.
2-Target must, like Apple, be conservatively managed, with a strong credit
3-Target must also be strong producer of normalized and prospective free cash flow
4-Target must be in a business Apple understands which can propel their respective competitive positions going forward
5-Target must have return on invested capital at least 3% above its cost of capital

When all these factors are set in motion, only one company stands out: Qualcomm

Ford Motor Company – Cost of Capital Improves, but …

January 28th, 2010

Investors should not get carried away with Ford just yet. Despite market improvement, its cost of capital is still some 70% higher than the median S&P 500 company, reflecting its credit and financial health are still tenuous.

The cost of capital, which is a function of the risk free rate and the firm’s credit health, suggests Ford stock should only be considered by speculative investors, willing to lose a substantial portion of their investment. Ford will be facing strong competition from China and possibly a resurgent GM over the years ahead, and with their long-term free cash flows in doubt, and reliance on debt ( $ $4 bil cash covenant requirement), Ford’s stock appears fully valued.

Ford - Cost of Capital

Off-Balance Sheet Leverage

December 20th, 2009

Thursday’s > 5% decline in Fedex vs UPS’s 1% decline vividly illustrates the importance of off-balance sheet leverage, namely operating leases.