Judging Apple’s Buyback Program
Since beginning to repurchase shares in 2013, Apple has spent $380 billion to buy back 10.6 billion shares at an average price of $35.80 per share. It’s tempting to think that Apple’s share buyback has been a success because Apple shares are trading 265% higher than the average price management paid to repurchase shares. However, one cannot judge buyback’s effectiveness or success by merely looking at the current stock price. Apple retires repurchased shares so there aren’t unrealized gains on the balance sheet from previously repurchased shares.
Share repurchases aren’t meant to boost stock prices even though some management teams may strive for such an outcome. Instead, share buyback is a tool for removing excess cash from balance sheets. In the process, a wealth transfer event is possible as ownership is shifted from shareholders willing to sell shares back to the company to those shareholders not selling shares. This is one reason why share buybacks are not created equally. Some companies incorrectly think buyback is a way to solve a problematic business model or lack of future growth while other companies see share buyback as a tool for balance sheet optimization.
The Above Avalon Report, “Share Buyback 101: An Examination of Apple’s Share Repurchase Strategy” contains much more detail on the wealth transfer dynamic found with share buyback. The report is available exclusively to Above Avalon members.
By repurchasing shares, a company doesn’t face brighter future prospects or even a higher stock price. The list of companies with stock prices that declined precipitously once share buyback concluded is long. Accordingly, a share buyback program’s effectiveness cannot and should not be judged by a company’s stock price.
End of Debate
Consensus agreed that Apple was holding on to too much cash on the balance sheet. However, there were differing opinions as to what Apple should do to remove the excess cash. Some thought that Apple should go on an M&A shopping spree. Twitter? Apple should buy it. Tesla? Apple should buy it. Netflix? Apple should buy it. Others thought Apple should ramp R&D so that as a percent of revenue, its R&D spending would be in line with that of its peers.
Instead of pursuing questionable expenditures such as large-scale M&A, paying special dividends, or simply saying “yes” to every R&D project imaginable, Apple instead saw an opportunity to both manage its balance sheet to a net cash neutral position (the amount of cash equals the amount of debt) and simultaneously invest in its future.
Apple’s share buyback debate didn’t end because Apple shares traded above a certain level, Apple repurchased shares below intrinsic value, or the company’s cash levels declined below a certain threshold. Instead, the buyback debate ended because Apple was able to successfully demonstrate that it can pile cash into buyback at record levels while also investing in its future at the same time. With Apple’s share buyback pace remaining at record levels, the company has been able to ramp up R&D to record levels while continuing to fund capex and pursue intelligent M&A.
What Did People Get Wrong?
Why did so many people underestimate Apple’s ability to both buy back shares and invest in its future at the same time?
People overestimated the amount of cash Apple actually needed to run the business and invest in the future.
People underestimated Apple’s ability to generate free cash flow.
As a percent of revenue, Apple’s R&D has historically been lower than that of its peers. Instead of this reflecting Apple underinvesting in R&D, the lower percentage reflects Apple’s unique culture and approach to product development. A better approach to take when judging Apple’s R&D spending is to compare current expenditures to historical totals. Apple spent more on R&D in FY2020 than the total it spent on R&D cumulatively from FY2010 to FY2014.
Apple’s capex needs are less than those of its peers. Apple has a capex-light business model because the company doesn’t offer free services to billions of people with a monetization strategy revolving around ads. This results in less property, plant, and equipment requirements.
Turning to M&A, Apple isn’t interested in buying products and users – a strategy that would likely be met with failure given the difficulty found with assimilating a target’s culture. Instead, Apple uses M&A to fill asset holes in the form of accessing technology and talent. This lends itself to Apple pursuing smaller deals involving companies with less in the way of thriving business models (and premium price tags).
Based on my estimates, Apple requires $10 billion to $15 billion per year to maintain and invest in property, plant, and equipment, and pursue intelligent M&A. Meanwhile, Apple’s business model predisposes the company to superior free cash flow generation. In FY2020, Apple generated a whopping $71 billion of free cash flow. The lack of significant capex requirements means that a high percentage of its operating cash flow ends up being free cash flow. As shown in Exhibit 2, Apple’s free cash flow has been increasing over time.
Exhibit 2: Apple Free Cash Flow (Annual - FY)
