How Should Apple Spend Its Money?

By Stephen D. Simpson, CFA | August 19, 2010 AAA
How Should Apple Spend Its Money?

Apple (Nasdaq:AAPL) has a problem - and it is a good problem to have. Products like the iPhone, iPod and MacBook, to say nothing of services like iTunes, have been so successful that Apple has accumulated more than $22 billion of cash and another $21 billion in long-term investments. With so much dry powder in the arsenal and persistent rumors about the health and legacy of CEO Steve Jobs, it seems reasonable to ask how the company might deploy this capital. Here are a few possible scenarios.

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Give it Back to Shareholders
This would be the simplest option, and there is no doubt that some shareholders would love to see a large-scale buyback or one-time dividend (or perhaps just a sustainably high regular dividend). Unfortunately, it seems like the least likely under current management. Simply giving back money and not applying it to some creative purpose seems very "un-Jobs-like," particularly when there are still mountains to climb and markets to conquer.

Moreover, while it may be fair to argue that Apple's cash really belongs to its shareholders, it is equally fair to argue that giving cash back to shareholders will do nothing to help the company produce more revenue in the future. In short, it is a "give up" move that would likely be seen as a sign that the company is out of ideas. (For related reading, check out What Would Jobs Do?)

Vertical Integration
There used to be an apocryphal rumor that Steve Jobs wanted to so fully vertically integrate Apple that sand, plastic beads, and copper would be dropped off at the loading docks and Macintoshes would come out of the other end of the process. Whether or not that rumor has any basis in truth, there is no question that tech companies used to pursue an integrated approach to hardware where they often expected to design and produce all of the components as well as the finished devices.

Since then, though, companies have gone the other way and chosen to focus on specific aspects of a product - where IBM (NYSE:IBM) and Digital used to do chips, components and software, the 1980s and onward were dominated by more focused companies like Intel (Nasdaq:INTC) and Microsoft (Nasdaq:MSFT).

Perhaps this trend is about to swing back the other way. Apple relies upon Infineon (OTCBB:IFNNY) for some critical components of the iPhone and iPad, and also uses chips from the likes of Skyworks (Nasdaq:SWKS) and Triquint (Nasdaq:TQNT). What happens, though, if a company like Intel makes a play for Infineon? Does that give Intel an unacceptably large say in the direction of future Apple products? Likewise, what if would-be rivals like Microsoft cozy up closer to chipmakers - do they get to reap the benefits of better integration between hardware capabilities and software design?

Expand Into a New Field
Does anybody believe that Steve Jobs is done yet? Having radically changed the portable music and cell phone markets, there are plenty of consumer technology markets left to target. What about TV and set-top boxes? Cisco (Nasdaq:CSCO) made a splash a few years ago by getting into the set-top box space, and Apple may choose to follow.

Consider the features that Apple could include on a set-top box integrated with the internet. Assuming adequate bandwidth, could Apple supplant the cable companies and offer their own television programming? Could viewers simply click on-screen to download a program or movie, or perhaps buy a product that they see showcased in a program or advertisement?

There are admittedly a lot of question marks here, but the advances that Apple made with the iPhone were considered largely science fiction only a few years before the iPhone introduction. Since then, smartphones have exploded and laggards like Nokia (NYSE:NOK) are barely still in the cell phone game.

With Apple making its imprint on how people listen to music and use their cell phones, targeting the television seems like a logical (if perhaps expensive) next endeavor.

Buy a Business
With so much cash on hand, it seems natural to speculate as to whether Apple would consider buying another company. Apple has done a few small acquisitions from time to time, but the company has overwhelmingly chosen to build instead of buy over the years. Why should that change now? Apple may see value in adding a critical component company like Infineon, or the company may believe that they can always find an independent company to work with should Infineon take a bid from another company.

Apple has a pretty distinct culture and operating philosophy, and any sizable acquisition would bring the risk of a culture clash. Moreover, Apple management may well ask the question of why they should buy something that they could build. A company like Netflix (Nasdaq:NFLX), for instance, could make sense to Apple but it seems that they could build their own online movie distribution system if they wanted to do so. Seeing as how Apple has really distinguished itself through innovative design (including features people did not know they wanted until they saw them), it is difficult to see why they would want to make a big acquisition - if they can already out-think their rivals, how does an acquisition (outside of vertical hardware integration) add value to the company? (For more, check out Which Is Better: Dominance Or Innovation?)

The Bottom Line
Investors waiting for Apple to share some of that cash pile with shareholders are probably in for a long wait. Steve Jobs is a visionary and visionaries are chronically long on ideas and short on capital. It does not make sense for Apple to give back money when the company still has prospects for earning high returns on that capital. Look instead for Apple to continue to disrupt large consumer markets with innovative new products and services - products and services that will require money to launch. (For related reading, take a look at CEO Savvy And Stock's Success Go Hand In Hand.)

Catch up on your financial news; read Water Cooler Finance: Billionaire Pledges and Other Positive Press.

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