Horace speaks carefully and with knowledge about opinions, facts and fantasies, and shares what he thinks John Ternus’s most important job is.
Topics include:
Listen to Asymetric in your favorite podcast app.
Research #Theory · 123 comments
To the nearest million, as of the end of September 2017, Apple's cash and investments totaled $268,895,000,000. Note that this includes investments in the form of short- and long-term marketable securities. Long-term marketable securities are not always accounted as "cash" because strictly cash is considered a liquid asset and some securities may not be sufficiently so. Nevertheless, most analysts would agree that Apple's securities are sufficiently liquid to qualify as cash. Note that for archaic reasons this cash is separated into US and non-US holdings with $17 billion located in the US.
Indeed Apple's cash is extraordinary. It amounts to about 30% of its market capitalization. One reason is that Apple has taken many loans, totaling about $100 billion.
Quite the contrary, Apple's operating cash flow is eye-watering. In the 2017 fiscal year (ending September) Apple generated $63,598,000,000 from operations. The loans are not needed to operate. They are used to pay shareholders.
Because it's their money.
Apple is holding it for them but if it has more than it needs it's obligated to return it. You see, If you were to look for "cash" in financial statements you find it on the balance sheet as an asset. Since it is growing and since a balance sheet has to balance, there has to be a liability that grows in proportion to offset the cash asset. That liability is called Shareholder's Equity. This is a "debt" the company has to shareholders. If it pays out cash to shareholders then it zeros out an asset and a corresponding liability. The net is zero as far as Apple is concerned but shareholders get something in return for giving Apple money in the first place.
Yes, welcome to tax laws. Although it generates more money than it can use, and that money should thus be returned to shareholders, some of the money is collected outside the US. US (and US only as far as I know) tax laws have a "repatriation tax" that is levied on money coming into the country. This has nothing to do with corporate taxes which are levied on earnings. So after paying shareholders with the cash it had in the US, Apple had to borrow money to pay shareholders money they had outside the US.
Because then shareholders would get less than 70% of their money. They would probably complain and blame the managers for being incompetent. Such blame usually comes with a lawsuit attached.
Now Apple has no option but to pay the tax and repatriate the cash. It's still a tax. The amount will be about $38 billion or about 15%. Previous repatriation "holiday" levies were around 10%.
The payments are called "dividends" and shareholders must treat them as income--a form of double taxation because these funds are after the company paid earnings tax and possibly repatriation tax. Apple does pay dividends regularly but because of tax inefficiency (i.e. because government policy discourages dividends) the company mainly buys its own shares and retires them.
Yes, it makes little sense but the math is simple. If the company buys its own shares and makes them disappear then existing shareholders will end up owning more of the company, making their shares more valuable. They can realize the gain if/when they sell the shares (and pay capital gains tax instead of dividend income tax on the already (double) taxed profits.)
No. The owners of the company remain the same: whoever owns shares owns the company and they can be traded in public exchanges. In theory they could reduce the share count to a single share and there would presumably be a single shareholder who would own the company, making it "closely held" but the company's managers are still required to report and act as if it was public. Going private usually means a set of shareholders agree not to allow the shares to float on the open market and thus to also keep the affairs of the company out of public eye. It reduces liquidity and is generally harder for shareholders to exit their investment. This has nothing to do with reducing the number of shares in circulation--which is what Apple is doing.
The share price is an argument between shareholders and potential shareholders on the value of the company. It should reflect reality but many times it doesn't. Over time however the math catches up with sentiment. In other words realization that there are fewer and fewer shares available compels people to not sell them, increasing the price. Short term investors tend not to pay attention to this but they are not the shareholders who Apple wishes to pay back anyway.
Simply, because it's more than can be spent wisely. The company considers its mission to be very narrow: add value in specific areas where they can create tremendous value uniquely and under conditions (technologies and business models) they can control. Many such projects don't require capital. Manufacturing, data centers and Apple stores require capital but R&D and sales not so much. Creating products is very cash efficient. For example, the iPhone--the most successful product of all time--cost almost nothing to develop; certainly nothing that required Apple to dip into its cash. Funding for the type of product development Apple does comes from existing cash flows and mostly consists of salaries for their employees.
It buys companies but usually small ones which are essentially acquisitions of teams and their intellectual property. Apple does not buy "business models" or customers or cash flows which is what large companies are valued for. Operationally, it's also because Apple has a strong culture and it wishes to preserve it. Acquisitions dilute culture which is why integrations often fail. Statistically, large acquisitions are value destructive and the larger they are, the more likely they are to fail. Incidentally, when a company is acquired with cash that hole in the balance sheet is filled with something called "goodwill" which reflects some intangible value of the new asset. If and when the acquisition is deemed to have failed the goodwill is written off and so is shareholder equity. That's how shareholders are robbed.
As individuals we think that having lots of cash makes us rich. For companies it's the opposite. Cash is a liability. If you come across a company that is cash rich and has nothing else, its enterprise value will be zero. Companies are valued on their future cash flows, meaning their ability to generate cash, not how much they managed to keep. In other words, cash is a measure of past success and investors are interested only in future value. That future value comes from the intelligent allocation of resources toward a valuable goal. A company rich in cash but poor in vision is likely to be taken private or broken up and shut down. Cash is an IOU to shareholders with a thank-you note for the support through the years.
The latest yearly report from Apple includes, as it has in the past, the forecast of Capital Expenditures. I've been tracking this data as an indicator of both strategic intent and potential forecasting tool for iOS device production.
Before exploring Apple's own forecast, we should look at how they met expectations for fiscal 2012.
In October 2011 the company forecast was as follows:
The Company anticipates utilizing approximately $8.0 billion for capital expenditures during 2012, including approximately $900 million for retail store facilities and approximately $7.1 billion for product tooling and manufacturing process equipment
In October 2012 it reported:
The Company’s capital expenditures were $10.3 billion during 2012, consisting of $865 million for retail store facilities and $9.5 billion for other capital expenditures, including product tooling and manufacturing process equipment, and other corporate facilities and infrastructure. The Company’s actual cash payments for capital expenditures during 2012 were $8.3 billion.
There are two points that need to be highlighted:
So it's important to note that the company spent a great deal more (one third more) than expected and paid for some of the acquisitions through uncharacteristic or unorthodox means.
The historic budgeting for Machinery & Equipment (+Land & Buildings) is shown in the following graph:
I included the forecast for 2013 ($9.15 billion) and added 18% to estimate 2013 actual spend.
The percent over/under budget (percent difference between green and blue bars above) is shown below:
[Again, note that I took the liberty of forecasting 2013 over-spending at 18% or $10.8 billion.]
Note that 2008 and 2009 were either on target or below target. The recession of 2008/2009 might have had something to do with that. The under-spending situation of 2009 was made up for during 2010 with over 45% extra spending. 2011 came in at 18% over and 2012, as already noted, was 34% over budget. I then suggest that 2013 will be at 18%, same as in 2011.
When seen in this historic context, the increase of 2012 is even more dramatic. Apple overspent in 2012 more than it spent overall two years earlier. 2012 spending on M&E (and Land) was up 138% sequentially and nearly seven times the level of three years ago.
With this splurge in mind it's necessary to think about that second noteworthy point above. There is evidence that at least some of the $2.3 billion over-budget was unanticipated and came late in the year. We saw the surge in spending in FQ4 from the gross asset value change data. The question is what was it spent on and why did it not go through the cash flow statement?
Circumstantial[2] evidence points to the asset being production equipment (or even a whole plant) previously owned by Sharp. Sharp is a key supplier of screens to Apple but is also in financial distress. Sharp has also been the object of an intended investment by Foxconn [Hon Hai]. That deal fell through as Sharp's finances deteriorated. My guess is that these attempts to shore up Sharp are directed by Apple to ensure both continuity of supply and a balanced supplier base (offsetting Samsung, another supplier.) If Sharp were to enter into some form of bankruptcy, the key plant(s) used in producing screens for Apple might be "up for grabs" by creditors and they might be taken off-line, jeopardizing Apple's production capacity, irrespective of contractual obligations. I believe that Apple's late and unprecedented expenditure was to secure this asset. I further believe that the financing for this deal was done through a swap of "pre-orders". Stepping even further into the hypothesis, I believe Apple arranged to move a Sharp screen production line onto its books and "paid" for it through a pre-payment of components. This being a pre-payment it would be in the form of an "off balance sheet" commitment. Apple reported that "As of September 29, 2012, the Company had outstanding off-balance sheet third-party manufacturing commitments and component purchase commitments of $21.1 billion" [my emphasis]. This is a significant increase from earlier years and allows for a huge "slush fund" to cover asset swaps.
If we take the timing of this expenditure into consideration, I consider it reasonable to assume that 2013 spending is lower by this amount. In other words, I think that about $2 billion, including the Sharp plant, may have been "brought forward" by a few months from 2013. If the company had spent more on schedule and on budget (i.e. with an over-spend of 15% rather than 34%) it would have spent about $8.2 billion. Therefore, as next year's forecast is for $9.15 billion and as I would also expect an over-spend of 18% or $10.8 billion total, adding the brought-forward $2 billion would imply sequential growth from $8.2 to $12.8 or 56%.
This is in contrast to the indicated change of $9.5 billion (actual) to $9.15 billion (forecast), or decrease of 4%.
So, recapping the CapEx story, the company over-spent far more in 2012 than anticipated. It did so late in the year. It did it while a supplier was in distress and another's supplier's efforts in rescue failed. Furthermore, it indicated a modest and thus uncharacteristic increase in the next year's CapEx budget. My take is that the trajectory of investment is not being altered dramatically but it's had an adjustment in timing, a kink in the line. The overall story remains that Apple is still injecting vast and growing amounts of capital into production and placing those assets on its own balance sheet.
---
Notes:
Research #Industry · 64 comments
In previous posts I described the patterns of asset value growth for Property Plant and Equipment at Apple and how that change has been thus far correlated to the production of iOS devices.
The analysis was based on looking at the declared value of the PP&E assets on Apple's balance sheet. These values include depreciation so they reflect not only the "spending" on new assets but also the value lost due to wear and tear. As such it's not a perfect measure of investment.
The better approach is to use declarations on the cash flow statement. Apple reports a specific cash flow related to PP&E: Under Investing Activities, Payments for acquisition of property, plan and equipment.
In the latest 8-K the amount for the 12 months ended September 29 the value was $8.295 billion.
Compare this with the statement in the Annual Report from one year ago:
The Company anticipates utilizing approximately $8.0 billion for capital expenditures during 2012, including approximately $900 million for retail store facilities and approximately $7.1 billion for product tooling and manufacturing process equipment, and corporate facilities and infrastructure, including information systems hardware, software and enhancements.
Compare also with the PP&E net asset value on the Balance Sheet currently at $15.452 billion but valued at $7.777 billion a year ago (an increase of $7.7 billion).
This means that Apple intended to spend $8 billion, actually spent $8.3 billion and realized a net asset gain (after depreciation) of $7.7 billion.
So there are no major surprises. The spending was only about 4% above expectations a year earlier.
The other pattern to observe is that the spending rose dramatically into the fourth quarter. The fiscal quarterly spending was:
I illustrate this pattern (and previous quarterly spending) in the following chart.
The question remains what is this $8.3 billion being spent on?
To help answer I also added the comparable spending (from cash flow statements) of a few other technology companies. Google, Amazon and Microsoft have been spending in the same range of $500 million per quarter. Over the past eight quarters the average spending of these companies has been:
Intel is different. Its average spend level has been $2.6 billion/quarter.
But Apple has just spent about 30% more than Intel. And it spent three times in Q3 than Google, 4.8x Microsoft and 3.8x Amazon.
The level of spending and growth from a far lower level implies to me that Apple is spending primarily on process equipment (aka tooling) rather than servers. Data centers are expensive at $1 billion for a large one, but they are not being built fast enough to account for $3.5 billion in one quarter.
Note that Apple's CapEx is above that of Intel whose fab-based semiconductor production method is known as particularly capital intensive. And Intel's Capital Expenditures have been increasing to all-time highs.
If Apple spent at Google levels on server infrastructure it would only be spending a quarter of what it's actually spending. If Apple spent on production at Intel levels it would only be spending three quarters of what it's spending.
In other words, Apple is spending at the equivalent of one Intel of fabrication and one Google of server infrastructure.
In a few days we will learn what the plan for expenditure for fiscal 2013 is. Historically, the company has roughly doubled spending for each year of the iOS platform. If that continues then Apple will be spending the equivalent of several Intels and several Googles.
I first noted a correlation between Apple's share price and its balance sheet a year ago. In February, when I last checked, Apple's share price was priced nearly at 4.6 times its cash value. The stock has had a brief rally but has returned to the trend line it's had since late 2008.
I should emphasize that this correlation between cash and price is abnormal. It should not be happening. Share prices for growing companies should be tracking its future potential, not its assets. I'm only presenting this data to highlight this abnormality. There is no fundamental basis for this happening. In fact, there is a basis for this not happening.
The relationship above is a symptom of another pattern called multiple compression that can be seen in the following charts:
The last chart in particular shows how as a function of earnings and growth, Apple is priced near a low. Certainly lower than during the depths of the 2009 recession.
Given this disconnect from the income statement, the pricing by balance sheet multiple seems to be a symptom of something deeper. Reasons vary with the seasons, but the company is not perceived to have sustainable growth.
At the end of 2011 Apple's net property, plant and equipment (PP&E) was $7.8 billion. This reflects $12.34 billion gross PP&E net accumulated depreciation and amortization of $4.5 billion. The depreciation and amortization increased by a total of $533 million and the gross PP&E increased by only $572 million. I say "only" because in the previous quarter PP&E increased by $1.42 billion. If we assume that this growth is equivalent to capital expenditures for the quarter, it's also a very small amount given the company's stated intentions to spend $7.1 billion during the fiscal year.
The gap is illustrated in the following chart:
The blue bar in the 2012 year represents the company's stated intentions (from the 10K). The Yellow bar in 2012 is what has been spent so far as measured by the change in reported asset values. Given that the company has been exceeding their targets lately, one should expect the yellow bar to reach as high as $8 billion after another three quarters.
Another view into this data is provided by the following chart.
The beige bars represent the quarterly change in asset value and the green bars are the depreciation expenses for the same quarter. This view also shows a significant slowing in spending.
In the past I showed that CapEx, especially spending on machinery, equipment and internal-use software correlates with iOS device production during the next quarter. It's not a relationship that helps much in quarterly predictions due to the elastic nature of product transitions. There were quarters when spending and output were de-coupled, for example spending in March and June 09 quarters was far lower than one would expect for the 3GS launch quarters that followed.
We will have to keep an eye on the change in asset value to be reported for CQ1 to see how the spending ramps up during the year. At this time the company needs to spend at least $6.5 billion in three quarters or over $2 billion per quarter to meet its target for the fiscal year (ending October this year). We have to see whether and why Q1 (fiscal) was too low.
This discussion is also affected by the discussion on Apple's other balance sheet item: cash and cash equivalents. The magnitude of its assets is staggering: $100 billion in cash, $7.8 billion in PP&E, $3.47 billion in acquired intangible assets (mainly patents), and $896 in Goodwill (acquisitions). With this much "capital" the company does not make use of any debt facilities.
In this regard Apple is also an apparent anomaly. As it gets subtracted out of indexes because it weighs too much or skews "reality" so Apple and its balance sheet is causing a warp in "time-space" of capital markets. The traditional relationship between financiers and operating companies assumed some form of symbiosis but as the credit crisis has shown some have not kept their part of the implied bargain.
So we have to ask yet another unsettling question: what is the value of capital markets when their products are commoditized by relatively unsophisticated CFOs?
---
Notes:
Balance Sheets are not typical targets of focus in software or services or "high tech" companies. Except for Cash, there are usually not much in terms of assets for analysts to contemplate. With outsourced manufacturing, even hardware companies don't maintain depreciable assets on their books.
Apple, as usual, is different. It turns out there is a lot there and there's a lot to learn from what's there. I've looked at the Cash and Long Term Securities in the past but in the next few posts I'll dive into fixed (non-current) assets. Specifically Apple's Property, Plant and Equipment.
Apple Inc. has selected North Carolina as the location for a new data center and will invest more than $1 billion in the project over nine years, Gov. Bev Perdue announced
via It's Official: Apple iDataCenter to North Carolina » Data Center Knowledge.
When Apple committed to the North Carolina data center in mid-2009 the iPhone was two years old. Only 26 million iPhones had been sold to date (about as many as Apple now sells every quarter.) Clearly if the commitment was on such a scale there must have been a plan. A big plan.
We don't know for sure if NC was used last week or whether it was handling only part of the load, but let's assume it was. What I want to think about is how much iCloud would thus cost and hence what would be the cost for alternative providers of such a service. That analysis might let us determine if "cloud" forms a substantial barrier to entry for competitors.
Beside the public statement above (which may have been designed for political benefit) can we find any evidence of what Apple spent on data centers? That's where the PP&E line comes in.
The following chart shows the Property, Plant and Equipment asset in Apple's Balance Sheet.
Each line represents a particular type of asset and its value at a particular point in time. I will now pay attention to the blue line, Land and Buildings. I'll look at the other lines separately.
Note that each line represent current value so it does not say directly what was happening in the quarter. However, if we look at the change q/q for a particular line we get how much new spending occurred in the quarter for that particular asset.
This change in Land and Building asset value is shown in the following chart:
Going back to 2005, there were minimal changes. Perhaps there is some significance in the $250 million spend in early 2006 or the nearly $78 million spent in Q4 2008, but there is a definite significance to the massive spending that occurred right after the NC commitment was made.[1] Some of that payment also included the old HP campus in Cupertino. "Local real estate experts said HP’s asking price may have been $300 million or more, but they also said the final amount may have been less."
There is also a clear cut-off on that spending at the end of 2010.
The total spending during this time adds up to nearly exactly $1 billion. If we subtract $250 million for the Cupertino expansion we still have $750 million that must have gone into NC.
Note that the original statement quoted above was $1 billion over nine years. We can see that Apple spent $0.75 billion in one year. On the building alone. This is why I consider this a down payment. It does not include any of the equipment in the plant. It does not include the cost of operation (incl. labor) or any development costs (R&D). In fact, it does not include any of the funds that would be part of the nine year commitment.
What this level of spending implies is that iCloud (and Siri and iTunes) are expensive. They may seem ephemeral and even trivial as services, but they require a staggering commitment few can make. Apple made that commitment and they made it early on, before the first quarter billion users were even on the horizon.
If platforms are moving from local to distributed and if value moves from selling things to "getting to know you" and if that knowledge requires infrastructure control then the number of companies that can participate in the market shrinks dramatically. Not only in terms of who has the capabilities, but who could even afford to acquire them.
The invoices Apple pays are shown above.
----
Notes:
Apple's share price has recently hit a new all-time high, over $400 per share. As often happens there was no specific new information from the company to justify this increase. On the other hand there is usually no news to justify share price drops in Apple. In fact, the stock is up on what would be considered counter-indicative news: the resignation of a very important CEO.
But readers may recall that there is a measure of performance for Apple we can turn to that seems to show strong correlation to its stock price. It's not income and it's not growth in income but it's the strength of the balance sheet.
I demonstrated this relationship last May with a post titled The market values Apple’s balance sheet, not its income statement.
It's time to look at the data again to see if the relationship still holds. I added the data for Q2 and made some estimate about the cash position since July 25th (we will know this data with more accuracy when Q3 data is reported in a few weeks).
The slope of the line above has decreased slightly but a strong correlation can still be observed. The old r-squared was 0.94 and it is now 0.90. I included the formula for the y variable (share price) as a function of x (cash).
If you plug in $100 for x you get about $500 for y. So if this relationship continues[1], the answer to the question in the title would be "When the cash and cash equivalents reach $100 billion."
----
Note:
