Apple is an interesting case study on how changing the structure of capital can increase the valuation of a company. Before 2013, AAPL had 0 debt and ~172B in cash/cash equivalents/ investments (treasuries, corporate securities, etc) on its balance sheet. I believe around this time Carl Icahn took a stake in AAPL and pushed Tim Cook to increase share repurchases and modify its capital structure to increase valuation. Today, AAPL has approximately 102 B in debt and 243 B in cash/cash equivalents/investments.
Although this is a very simplistic way of looking at things, I think Carl Icahn was right because the resulting change in capital structure has increased valuation. With the cash on AAPL’s balance sheet returning barely anything (in the 1.7% range) why not repurchase shares and increase the amount of “cheap” debt? Repurchasing shares would concentrate shareholder ownership of AAPL and lift up share prices. Using cheaper debt would lower its weighted average cost of capital (WACC) and therefore lower its discount rate and raise earnings multiples. Obviously taking on debt can be risky but I believe the risk is reduced for companies like AAPL which have fortress balance sheets and huge amounts of FCF. Totally removing share based compensation from FCF (conservative approach), AAPL has done a little over 100B in FCF the past two years.
| Date | JUL-2011 | JUL-2012 | JUL-2013 | JUL-2014 | JUL-2015 | JUL-2016 | JUL-2017 | JUL-2018 |
|---|---|---|---|---|---|---|---|---|
| FCF / Share | 4.32 | 6.11 | 6.29 | 7.56 | 11.51 | 8.43 | 9.1 | 11.09 |
| (Cash - Debt) / Share | 11.75 | 17.88 | 20.16 | 22.19 | 25.9 | 26.93 | 29.48 | 26.45 |
| Average Price (3 mos out) | 40.13 | 69.32 | 61.09 | 99.61 | 113.56 | 110.1 | 157.87 | 205.22 |
| FCF Multiple | 6.57 | 8.41 | 6.5 | 10.24 | 7.62 | 9.86 | 14.11 | 16.13 |
| Debt/Total Asset Ratio | 0 | 0 | 0.08 | 0.14 | 0.2 | 0.28 | 0.31 | 0.33 |
*All values are TTM except average price
As you can see, as the debt/total asset ratio slowly increased, the FCF multiple has also increased. I think financial theory explains why this is happening. Debt has a cost of capital somewhere between the risk free rate and the cost of equity. AAPL’s cost of debt is probably very close to the risk free rate. As said before, this lowers the discount and increases valuation.
One thing to watch in the next couple of quarters starting in 2018/2019 is that AAPL will start having debt mature and will have to pay back some debt. I am not sure why AAPL doesn’t have an interest expense line in its 10Q/10Ks (can someone let me know why?) but the weighted cost of interest seems like it is less than what the 10-yr treasury yields.
Looking forward, the future looks OK for AAPL. AAPL will probably do close to 250B in revenues by the end of the fiscal year with stronger demand for iPhones and increased service/wearables revenue. This will translate into about 12 $ FCF / share. This means AAPL is currently trading at about 16 times forward FCF (subtracting cash and adding debt). Thoughts?
Submitted August 25, 2018 at 08:51AM by resumeherenow https://ift.tt/2OZva8s
