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Why Apple's cash is worth more than Microsoft's cash

My recent exposé of Apple’s cash (and cash equivalents and long-term securities and short-term securities) drew quite a bit of attention, which is good. Because it needs to be demystified. However, the story does not end there. Part of the problem of cash is that the liquid stuff can often itself change in perceived value due to mis-management.

Cash has to be valued on the basis of what’s to become of it. So what can become of it?

The value in liquid assets can be returned to shareholders in the form of a dividend, which means double taxation on profits; not the best idea usually. Or it can be returned in the form of share re-purchase which tends to have only a temporary effect on share prices, again not a great return. The value can also be increased by means of investment in projects that return higher than what investors expect their cost of capital to be. This is the best option but investment is difficult when the amount involved is so big that no project or set of projects could possibly cost enough to employ the capital. Finally, the value can be completely destroyed through large acquisitions.

I say destroyed because the history of large acquisitions is almost universally known to be value destructive (1). The urge to M&A is why cash on the balance sheet for large companies is usually discounted and share prices “get no credit for it.” This is plaguing Apple with a P/E ex-cash in the teens.

Is this fair?

Companies faced with low growth are more likely to blow their cash on desperate acquisitions than those with high growth, but the best way to judge the probabiliy of cash evaporation is by looking at management track records.

Which leads us to Microsoft.  Their pursuit of Yahoo shows how desperate they had been in trying to catch Google and how poorly that would have turned out. Having failed only because Yang refused to sell, Microsoft would have gone through a large part of its cash and even raised debt to finance a dud.  With this propensity, it’s no wonder that Microsoft’s cash is considered an endangered quantity.

Microsoft used to have the largest cash position in tech. They still have $44.5 billion–a mere billion or so less than Apple. Some of the value already evaporated on dividends and medium sized acquisitions ($500 million for Danger that ended up as Kin(dling)). The chances that they’ll blow billions again on desperate means to chase competitiveness are high. I would say it’s a certainty.

On the other hand we have a high growth company like Apple that has not traditionally spent money on business acquisition. (They do spend on asset acquisitions–IP, code, developers but not on new business models.) Thus, on reputation alone, Apple’s cash can be considered “safer” and hence worth more than Microsoft’s.

Whether Apple can expose that cash to risk that enhances its value is another matter, but their CEO is on the record stating that “it’s not burning a hole in their pocket” and the CFO repeats every quarter he is intent on its preservation.

This, in my opinion, makes the difference between Apple’s $45 billion and Microsoft’s $44 billion a lot more than $1 billion.

(1) Various studies have shown that at least 50% of acquisitions have been rated as failures. See failure rates by various studies charted below. Source: Prof. Dr. Thomas Straub (2007) “Reasons for frequent failure in Mergers and Acquisitions”

  • Paul Eccles

    I agree with your analysis. This is exactly why I wanna buy Apple stock, even at $250+. Just gotta figure out how to do it from South Africa.

  • Rory

    AAPL vs. MSFT seems like an odd comparison to make, for two reasons:
    1) MSFT has also not traditionally pursued big-ticket M&A. i.e. in 2007 you could have said that MSFT was unlikely to go do something stupid like try and buy Yahoo. Nobody (including AAPL) is ever likely to make a massive, transformative, bet-the-whole-company-on-this-deal kind of acquisition…until they do it.
    2) MSFT in recent years has returned money to shareholders, via dividends and buybacks, whereas AAPL has left their cash balance sitting around to collect interest. While I don't necessarily think AAPL should start kicking out dividends, it seems odd to argue that investors should be excited about AAPL's investments in T-Bills and CDs.

    You kind of left your argument without a conclusion. What do you think AAPL is going to do with $45bn in cash? How is that going to create value? I'm not sure why you think that the fact that it is "safer" means that it should be valued at a premium. The only argument you've really made is that AAPL is unlikely to throw it away on stupid acquisitions. Ok, premise granted–so what?

    • http://www.asymco.com asymco

      Prior to 2007, Microsoft had no merger fever but their anxiety about growth was what drove them to it. It's fine to say that Apple could snap and do something stupid with cash randomly, but Microsoft's slide into desperation was a long time coming.

      Regarding returning money to shareholders, Microsoft's actions did not help much to increase returns.

      I'm not excited about AAPL taking 20% of my money and using it to fund federal deficits, and you're right that I left the argument about what to do about the cash unanswered. My intention was not to propose a solution, but to point out that there are worse things to do with it than what Apple's doing now.

      At a basic level, I'm arguing that the cash adds positive option value to Apple's valuation whereas it adds negative option value to Microsoft's. This is a matter of perception.

      • Rory

        Ok, all fair points. And I guess I can buy into the title of your post: that Apple's cash is worth more than MSFT's, due to the positive/negative option value. Nonetheless, it is still only option value and there aren't any particularly promising options on the table. They have picked up their M&A activity a bit lately–although they have not exactly demonstrated commanding competence therien (see: admob)–and the more active/aggressive they become with small targets, the more that investors will wonder if they are warming up for the Big Stupid Deal. I think it is just too much of a question mark overall.

  • JonathanU

    I agree with your assumptions regarding MSFT being more of a liability with their cash hoard than AAPL. However, you didn't really give your own opinion as to what AAPL, and MSFT for that matter, should do with their billions?

    You mention the four alternatives, dividends, stock buy backs, investing the cash in positive net present value (NPV) projects, or blowing the cash on value destroying M&A. However, for each one you discredit both company's options. So what to do?

    My personal opinion on this matter is pretty strong. I feel that AAPL and MSFT should be buying back their shares as fast as possible. You have been arguing for a long time that AAPL is undervalued. Well if management really thought that this was the case, what better use would there be than to buy back the company's shares?

    When I buy shares in AAPL, I want to gain as much financial exposure to the company's operating business, not waste 20% of my capital on buying T-bills and other exceptionally low yielding assets.

    However, I do seek comfort in the fact that this issue will resolve itself in the near future. The embarrassment of riches will no doubt force the hand of AAPL's management to do something with the cash as the pile will soon grow to an obscene level in the next 12 months.

    Perhaps both MSFT and AAPL could look a little more closely at RIMM's management to see what a more attractive balance sheet, in terms of an investor, looks like!

    • http://www.asymco.com asymco

      If Apple really could find no better use for the money, then a buyback is the best option, but don't forget that once spent, the option value for that cash is gone. In other words, holding the cash gives management an additional lever of control, that, even if not used, has potential. As in all these questions of finance there is no definitive answer that is "right" or "wrong".

      • JonathanU

        I take your point re option value regarding the cash on AAPL's balance sheet. However, I struggle to think of what they could possibly need $45bn for, not to mention the fact they could quite easily raise another $25bn in debt if they so needed the cash that badly.

        Do you have any thoughts as to what they could need this amount of financial firepower for? I am at a loss as to what they could do that would be value creating that would need $45bn in cash? The only thing that comes to mind is M&A, and the thought of a large acquisition on that scale would be highly unlikely to be value enhancing.

        Surely it's time for a massive share buy back to significantly raise EPS etc.?

      • http://www.asymco.com asymco

        I've suggested in the past that the only capital-intensive solution to a problem that they have today is to buy manufacturing capacity. They are outsourcing manufacturing but in-sourcing more and more of their other value chain (retail, chip design, maps, etc.) I don't have the means to evaluate or quantify a shift back into manufacturing for Apple, but it seems to me an obvious thing. (Not to mention that the volume leader Nokia manufactures in-house).

      • JonathanU

        I tend to agree with you on this. Using their cash to ramp up supply of their highly desired products is a must. Especially as the number of iPhones sold enters the 100m+ per annum level (which I believe you produced some analysis on previously at AFB which indicated this was approximately 3 years off, given smartphone market growth rates and iPhone market share etc.?).

        However, given manufacturing is pretty low margin work, I don't advocate an entire shift to in-house manufacturing. I think the focus should be on sorting out the iPhone's future supply and potentially also the iPad's. The steady growth rate of desktop/portables is fairly easy to cater to and therefore outsourced manufacturing of this product set is probably still the way to go.

        Either way you look at it though, there is still a bounty of surplus cash on the balance sheet that should eventually be returned to shareholders. Buybacks certainly being the number one method to do so…

  • Sam

    To be honest, I am quite happy with the cash they have. I see no reason for them to do anything unless they find something good to do with it.
    At this time, it looks like the market is not even giving much value at all to their position and I would leave this problem up to SJ to decide what he feels best.

  • Plough coofu

    Apple nearly died once before. People always accuse Jobs of hubris, but I think the cash holdings prove the opposite. He may be very cognizant that in the tech business, the rug can get pulled out from under you in a heartbeat. He's done it himself to enough other companies. If he believed his vision alone would keep Apple safe, I don't think there'd be any need for that huge war chest. But if he's smart–not just arrogant–he knows different. He's had to painfully rebuild his company before, and he's making sure he's prepared to do it again.

    Put it this way, it might have seemed ridiculous for Motorola to have a huge cash reserve when they were selling the Razr like hotcakez–but they'd sure love to have it today.

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