Icahn’s Big Apple Stake Doesn’t Change Our Thesis

We are maintaining our fair value estimate and moat rating for  Apple (AAPL) after the stock received a $15-per-share boost on Tuesday afternoon following the disclosure by investor Carl Icahn that he has a large position in the stock, which the Wall Street Journal believes is roughly $1 billion, and had a recent discussion with Apple CEO Tim Cook about further share repurchases. The news does not change our underlying thesis about Apple, although it clearly added to recent positive momentum around the stock that began with strong June quarterly results and likely continued after reports suggest that new iPhones will be introduced on Sept. 10.

The only fundamental news item, in our view, revolves around Icahn’s discussion with Apple’s management team about further share repurchases. Apple is currently authorized to buy back $60 billion in stock through the end of calendar 2015, and we think the company made a shrewd round of purchases totaling $16 billion in the June quarter as part of this program. In order to fund future purchases and not drain the firm’s U.S. cash balance, Apple will likely need to take on additional debt, since the majority of the firm’s cash is held overseas and is unavailable for dividends or buybacks without paying roughly 35% in additional taxes. Apple’s initial venture into the debt market with the issuance of $17 billion of bonds (which in turn funded the $16 billion buyback in the June quarter) was done at extremely favorable interest rates. With the rise in 10-year Treasury yields to 2.7% since that time, as well as the fact that bond investors already have the ability to own Apple debt today, we anticipate that it will be a bit more costly for Apple to issue a second round of debt to fund further buybacks. Similarly, a new round of buybacks would still be a good use of capital, in our view, but not nearly as attractive as it would have been just a few months earlier when Apple was trading below $400. Other than encouragement to pull the trigger on further buybacks, we tend to think that Icahn’s investment would be one of his more passive ones in terms of owning a cheap stock, rather than an aggressive, corporate raider-type move to shake up the board or split up the company.

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