Apple's Cash: Leave It Alone, Mostly

Posted by: Arik Hesseldahl on December 07

In March, I argued first in my online column and then later in a commentary in the magazine that Apple should start doing something with its enormous and steadily growing pile of cash. At that time it was $12 billion. Now its $15 billion, and the question isn’t going away.

At the time I argued, that at least one way to use it would be to start a $1 billion venture capital fund, something along the lines of what Intel has done with Intel Capital. The chip giant has invested $6 billion in more than 1,000 companies since 1991. I still think its a pretty good idea. Apple has as much interest as anyone else in influencing the development of the tech economy, whether that’s done through its own products, which are the result of its own research and development, or through helping third parties get their own ideas off the ground with equity funding. But $1 billion is only 6% of Apple’s cash. What to do with the remaining 94%?

Jon Fortt at Fortune raises the cash issue again, and suggests investor impatience. He discusses the usual options: dividends, stock buybacks, and acquisitions. All have their downsides, he concedes. Dividends and buybacks are difficult to stop once you start, and in fact, if I remember correctly, there’s still an authorized buyback program in force. That leaves acquisitions. Fortt says that Apple could roll up Tivo, Circuit City and Netflix, and still have a lot of cash left over. I figure for those three Apple would have to spend at most $5 billion, laying aside the fact that the only one of those three that makes any sense at all is Tivo, and even that is, in my opinion, a stretch.

I agree that the questions are going to get louder, and I think a little more impatient. Assuming Apple generates as much cash from operations in 2008 as it did in 2007, Apple will, in a year’s boast a cash position at or near $20 billion, roughly equivalent to its fiscal 2006 sales, and two-thirds the size of its projected fiscal 2008 sales. More after the jump.

Consider another metric: When compared to other tech giants, Apple about the richest there is. Its cash position as a percentage of total assets is north of 70%. That's higher Microsoft at 32%, Hewlett-Packard at 33%, and Intel at 60%. Cisco Systems is about on par with Apple at about 70%.

So what good is all that cash actually doing? Apple's 10K filing says it earned an average interest rate of 5.27% during the year, higher than the 4.58% during 2006 and the 2.7% it earned in 2005. You can certainly argue that this is only a little higher than a good savings account or CD.

These are indeed, dizzying numbers, and at first glance, cause for investor concern. But that concern is easy to overstate when you look closely at the 10K.

But the cash has a real strategic purpose: Apple can use it as a hedge in supply negotiations. The one known example is NAND flash memory. Samsung, Hynix, Toshiba and others have in recent years all been targeted with big supply deals committing them to supply Apple with flash chip used in the iPod and iPhone. The flash business is volatile and tends to move in boom and bust cycles. By locking up large percentages of the available supply, Apple ensures it will never need to worry about supply constraints. Market research firm iSuppli reckons that in 2007, Apple spent $1.8 billion on NAND flash, and consumed just less than 20% of the world's supply. The only one who consumed more? SanDisk, but SanDisk sort of doesn't count because it is actually a manufacturer of flash memory, and consumes its own supply.

Apple's flash purchases are generally done in advance. Its 10K says it paid $1.25 billion up front for NAND supplies in 2006, and had used up $208 million worth of that during the fiscal year. And if you dig further through the 10K you find that $417 million worth of flash purchases are counted as part of "other assets" line item on the balance sheet, which totals $3.8 billion.

In a pinch, it can use its ability to pay large amounts of cash quickly in negotiating supply agreements on any important commodity component that runs the risk of running short: DRAM memory, LCD or touch screens, etc.

So you see, but keeping the cash sitting there, earning relatively low interest, is actually a good thing. Its held in reserve for the day when it's badly needed to stave off what could be a costly supply problem that would prove disastrous. Imagine what would happen if flash supplies ran tight next fall, and Apple was unable to ship enough iPod nanos and had to instead sell empty boxes with the promise of delivering a finished product in January or February. It would be a disaster, and a major blow to Apple's brand equity, not to mention its stock price.

So as much as I still like my idea of a venture capital fund, I'm less inclined to join the chorus of people who would pressure Apple to start paying a dividend, aggressively buying back stock, or going on an acquisition binge. That stash of cash is doing just fine right just as it is. But if it gets much bigger, I'm going to change my tune.

Update: Peter Kafka over at Silicon Alley Insider suggests Apple think big and go on "an M&A bender". How about a music label like Warner Music Group, or a movie studio like Lion's Gate and/or MGM? Forgive the trip down memory lane, but Peter and I used to work together for another organization, and we collaborated on a story in 2003 that revealed some of the details about Apple's plans for what became the iTunes Store 17 days before the official announcement. But at the time, the more intriguing rumor was swirling that Apple was mulling a bid for Vivendi's Universal Music Group.

TrackBack URL for this entry: http://blogs.businessweek.com/mt/mt-tb.cgi/