Hold On Before You Chase Icahn Into Apple

After a string of spectacular investments, Carl Icahn tweeted on Tuesday at 2:21 p.m., “We currently have a large position in APPLE. We believe the company to be extremely undervalued. Spoke to Tim Cook today. More to come.”  Apple stock was trading at $475.81 just before his tweet and shot higher right after his tweet.

Icahn had previously stated that he would announce his next major investment on Twitter; therefore investors were on high alert.  Four minutes later, Icahn added fuel to the fire with another tweet: “Had a nice conversation with Tim Cook today. Discussed my opinion that a larger buyback should be done now. We plan to speak again shortly.”  The stock ran up to $494.66 before giving up some of the gains and closing at $489.57, up $22.21 for the day.

Should investors follow Icahn into Apple stock?  For an answer, consider the following factors.

Technical Picture

Apple shares have reclaimed their 50- and 200-day moving averages in the past three weeks.  This is positive, but the stock faces heavy resistance in the zone of $510 to $530. Think of two different types of investors: short-term traders who jumped in on the Icahn news, and long-term investors who are sitting on unrealized losses. When Apple stock was falling, heavy buying occurred in this zone. The investors who bought there may start selling or lightening up when they reach breakeven.

Unless there is solid news on new products, the stock will have difficulty overcoming this resistance. In the absence of excitement about new products, the stock may reach the resistance zone on exuberance about Icahn, but then back off to under $500. It is worth noting that the rumor mill is full of potential announcements regarding a low cost iPhone, iPhone 5S, and a thinner iPad.   If these new devices are merely evolutionary, they may not build enough excitement to overcome the technical resistance.

Icahn’s Cost Basis

At the time of this writing, Icahn’s cost basis is not known.  His average cost for the stock may become a matter of public record either directly from his statements or from filings with the Securities and Exchange Commission (SEC).  It is safe to say that his cost basis is likely to be much lower than $475.81 where the stock was trading prior to his tweet.  A reasonable estimate of his cost basis can be made by looking at Apple’s chart.

On June 28^th, Apple stock traded at a low of $388.87, this is so far the cycle low for the present cycle in the stock.  On July 23^rd, Apple traded at a low of $418.99, on July 24^th it gapped open at $438.93 and since then the stock has been on an upswing.   Icahn’s buying certainly contributed to the buying pressure seen in Apple recently.

The point is that Icahn is already ahead in his investment and anyone following him now will be taking a higher risk.

Size Of Icahn’s Investment

Icahn calls his investment in Apple large.  Bloomberg reported that his investment is more than $1 billion.  A billion dollars is nothing to sneeze at, but it should be looked at in the context of the market capitalization of Apple which stands at about $445 billion.   The point is that the size of the investment by itself does not carry enough weight but Icahn’s name as a successful activist investor is to be reckoned with, especially by the Apple Board of Directors.  Icahn’s investment will become a catalyst for change at Apple. So far the investment seems friendly.

Not A Repeat Of Netflix

Even if Icahn’s investment in Apple is successful, it is not likely to come close to the spectacular successes he has achieved with the likes of Netflix (NFLX), Herbalife (HLF), and Chesapeake Energy (CHK).  He bought about 10% of Netflix or about 5.5 million shares at $58 per share in late 2012.  Netflix stock closed at $259.19.  This is a profit of over a billion dollars in a few months.

Icahn is projecting a target of about $700 for Apple or about a 40% upside from here. Icahn is basing the target on a $150 billion buyback and earnings increase at the rate of 10% without any change in the price earnings multiple.

Earnings

An earnings increase at the rate of 10% for the foreseeable future is not a safe assumption.  If innovation at Apple does not accelerate from its current pace, in my analysis, Apple’s earnings will decline.  Icahn figures that even without earnings growth, Apple should be worth $625.

Buybacks

Icahn is advocating large buybacks.  Apple is a cash rich company but a large amount of the cash is being held oversees.  Unless Apple decides to pay U. S. taxes by repatriating some of these funds, Apple will need to resort to borrowing for stock buybacks.   Apple can do $150 billion of buyback over the next three to five years and still have interest coverage of over 10 times.

On the surface, it all makes sense.  Based on conventional fundamental analysis, Apple is not allocating its capital most efficiently at this time.  Icahn is the catalyst for Apple to do a better job at capital allocation.  Having said that, one has to ask the question; “Will there even be an iPhone 30 years from now?”  Apple may borrow for a period of 10 to 30 years.  Considering the speed at which technology changes and the competition that Apple faces, it is difficult to see with certainty what Apple’s cash flow will be 30 years from now or even 10 years from now.

It is telling that Apple bonds fell after Icahn’s tweets.  Apple’s 2.4% paper due May 2023 gave up about 1.6% in value.   Investors in Apple’s previous $17 billion bond offering have suffered major losses recently.

Icahn is no stranger to technology.  He was the catalyst for selling Motorola to Google (GOOG).  However, Apple is simply too large to be sold.

Some degree of caution is warranted in following Icahn.  As successful as Icahn has been, like most investors, he has not batted 100%.

Follow me here, write me at Nigam@TheAroraReport.com or find me at The Arora Report. 

Disclosure: The author has recommended Apple to subscribers of The Arora Report.