What's the best way for it to spend that money? If the Apple board is doing its job, it will use some of that to find a replacement for Steve Jobs, the world's greatest CEO when it comes to designing, building and selling innovative products that transform large, previously moribund industries.
As talented as Jobs is, he's also human, which means that when he is no longer in charge, Apple will probably go back to being what it was under his predecessor, John Sculley: a company that limps along with old products but struggles to innovate. Someone as good as Jobs is might be running another company now, and one way to hire that person would be to buy that company -- as Apple did when it rehired Jobs by acquiring his post-Apple firm, NeXT.
Which company would that be? There isn't one, because there is no one out there who can fill that turtleneck. Which makes me think: Maybe the board should just pay a large portion of that $25.6 billion worth of cash to shareholders.
What Makes a Good Acquisition
To analyze acquisitions, it helps to have a way to compare them. Since most mergers fail, boards should make sure they don't slam into any of the four icebergs that typically sink such deals after they occur: an unprofitable industry, an uncompetitive set of combined skills, overpaying, and the inability to integrate. To that end, here are four tests which any acquisition should pass:
- Industry Attractiveness: Does the industry the acquired firm is in have high profit potential?
- Better Off: Will the combined companies be able to capture a significant share of that industry due to their combined skills?
- Integration: Can the two companies merge their organizations smoothly so the deal is seamless to customers?
- Price: Is what the buyer pays for the target low enough that shareholders will get a return on the investment?
- Facebook. AllThingsDigital suggested this possibility. But at an estimated price of $35 billion to $40 billion, such a deal -- --would fail the price and the better off tests. Apple has nothing useful to add to Facebook, so there's no realistic scenario in which the combined companies could generate enough additional profit beyond what Facebook can earn on its own to justify paying that much. Apple doesn't need to spend $40 billion to make Facebook's 500 million users aware of iTunes and its other products.
- Netflix (NFLX). DealBook mentioned this idea. At an estimated price of $10 billion (assuming a premium over its current $7.8 billion market capitalization), such a deal would also fail the price and the better off tests. Netflix is trading at a P/E of 61 and its earnings are forecast to grow at slightly more than half that rate, 33%, so the stock is already overpriced. And, as with Facebook, there is nothing obvious that Apple could offer that would add to Netflix's DVD rental or online streaming businesses. If Apple wanted to create an iVideo store, it wouldn't need to buy Netflix to do it.
- Electronic Arts (ERTS). At an estimated price of $5 billion -- the current market value of this money-losing video game company -- such a deal -- again suggested by DealBook -- would fail the industry attractiveness, price and the better off tests. The multimedia and graphics arts software industry has a five-year average return on equity of 0.6% (way below the S&P 500 average of 16.3%). Apple has nothing to add to Electronic Arts, meaning there's no realistic scenario under which this money-losing company would recoup the $5 billion it would take to acquire it. If Apple wants to get into the video game business, it should hire some engineers and design its own gaming system.
Apple generates more cash than it can profitably reinvest. It averages about $1 billion in capital expenditures every quarter and still manages to add $1 billion a quarter to its cash and short-term investments. I propose that Apple shareholders would be better off if its board declared a $20 billion one-time dividend and then paid out $1 billion in dividends regularly every quarter.
Would investors lose interest in Apple if that dividend payment was made? I think it depends on whether Apple can continue to invent hit products. As long as it does that, investors will get a double benefit from owning Apple stock -- income and growth. It may be boring, but unless Apple can find another company to buy whose CEO rivals Steve Jobs for creativity, it makes more economic sense than throwing away $40 billion to buy Facebook.