What’s the Next Chapter in Apple’s Storybook Capital Return Program?

source: http://www.flickr.com/photos/julialeiby/

source: http://www.flickr.com/photos/julialeiby/

At their best, share repurchases are a tricky thing, particularly in the technology industry, where valuation is sometimes difficult to understand, and a company can get into a lot of trouble buying its own stock. Dell (NASDAQ:DELL) infamously botched its buyback strategy and effectively wasted a huge amount of cash by purchasing shares at a high premium. The nearly $40 billion fiasco has become the gold standard for what not to do with a buyback program, and its zeitgeist has been summoned in reference to Apple’s (NASDAQ:AAPL) tremendous capital return program.

In a 1999 letter to shareholders, Warren Buffett, of Berkshire Hathaway (NYSE:BRKA)(NYSE:BRKB) notoriety, offered what is perhaps the most succinct commentary on share repurchases: “There is only one combination of facts that makes it advisable for a company to repurchase its shares,” he wrote. “First, the company has available funds — cash plus sensible borrowing capacity — beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively-calculated.”

Apple, to date, appears to have executed its record-setting share repurchase program with competence. In the June quarter, Apple bought 36 million shares at an average price of $444.44, and in the September quarter it bought 10.4 million shares at an average price of about $480. At these prices, many investors feel like the company is not overpaying for its own stock.

At $520, though — about where the stock is now — Apple Insider calculates that Apple would have spent $3.1 billion more on repurchases over the past two quarters. It’s at this price, perhaps, that the repurchase program starts flirting with trouble. The company obviously does not want to repurchase shares at a premium to the market.

“Price volatility over a given period may cause the average price at which the Company repurchases its own stock to exceed the stock’s price at a given point in time,” Apple said in its 10-K filing with the Securities and Exchange Commission. A standard disclosure, but one that is particularly relevant as Apple stock edges higher with holiday sales expectations. Shares are up about 14 percent over the past six months.

For his part in the whole situation, activist investor Carl Icahn has urged Apple to announce a “$150 billion tender offer” at $525 per share, financed with funds borrowed at a 3 percent interest rate. Apple issued debt to finance its current repurchase program. CEO Tim Cook has met with Icahn and has commented that the repurchase program is continuously studied.

Apple’s board authorized the $100 billion repurchase program in April, when it also raised the dividend to $3.05 per common share, which went into effect in May. The next payout is expected on Thursday, when Apple will distribute $2.8 billion to shareholders of record November 11.

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