Getting rid of Samsung as a processor supplier and, at the same time, capturing the crown jewel of the American semiconductor industry. How could Apple resist the temptation to solve its cash problem and make history again?
Halfway through the second quarter of the 2013 fiscal year, most of Apple's top execs meet at an undisclosed location (Eddy Cue's chair is empty – he's been called away to a Ferrari board meeting). They're joined by a few trusted industry insiders: Bill "the Coach" Campbell, Apple and Intuit Director and adviser to Google's founders, Mssrs. Page and Brin; Larry Sonsini, the Silicon Valley consigliere of more than three decades; and Frank Quattrone, the star investment banker with nine lives.
The meeting isn't about the company's dwindling profit margins. The smaller margins were expected and invited: The reduced-price iPad and heavy promotion of the "old" iPhone 4 as an entry-level product are part of the long term strategy of guarding Apple's lower end (so to speak). And no whining about AAPL's grim slide over the last six months, a problem that has only one solution: Apple needs to record a series of better quarters.
The problem of the day is, once again, what to do with Apple's obscene pile of cash.
By the end of December 2012, the company held about $137B in cash (or equivalents such as marketable securities), including $23B from operations for the quarter.
CFO Peter Oppenheimer delivers the bad news: It looks like operations will disgorge another $35B this quarter. The stock buy-back and dividend program that was designed to bleed off $45B over the next few years (see this March 2012 Monday Note) won't be enough if the company continues at this rate.
Apple needs something bigger.
Quattrone has been sitting quietly at the end of the table. He clears his throat and speaks:
Well, yes, Frank (says Tim Cook), we've been buying Intel processors for the Mac since 2005.
Not the chips. The company. The planets are aligned for Apple to strike a blow that will leave the industry forever changed. Make history, acquire Intel.
Quattrone has their attention. He unfolds the celestial calibration:
- Apple needs to extract itself from the toxic relationship with Samsung, its ARM supplier.
- Intel is the best large-scale silicon manufacturer in the world. They have the people, the technology, and the plant capacity to match Apple's needs for years to come.
- "But Intel doesn't do ARM!" you say. Indeed, Intel has no interest in the fierce competition and small margins in the ARM-based SoC market. Joining the ARM fray would severely disrupt Intel's numbers and infuriate Wall Street. But if Intel were to essentially "go private" as Apple's semiconductor manufacturing arm (pun intended), catering to all of Apple's x86 and ARM needs (and whatever else Bob Mansfield is secretly plotting), Wall Street would have no such objection.
- Intel is flailing. The traditional PC market – Intel's lifeblood – continues to shrink, yet the company does nothing to break into the ARM-dominated mobile sector. In the meantime, the company makes perplexing investments such as buying McAfee for $7.68B.
- There's a leadership vacuum at Intel. Six months after announcing CEO Paul Otellini's "retirement", Intel's Board has yet to find a replacement who can sail the ship in more competitive waters. Apple could commission Pat Gelsinger, a 30-year Intel veteran and former CTO (Intel's first) who fled to VMware after his career stalled at Intel. Despite being a bit of a Bill Gates look-alike (once upon a time), Gelsinger is a real technologist who would fit well within Apple, especially if he were given the opportunity to really "go for" the ARM architecture instead of iteratively tweaking x86 devices.
- Last but not least, Intel's market cap is about $115B, eminently affordable. The company is profitable and generates a good deal of cash, even after the heavy capital expenditures required by its constant need to build new and expensive manufacturing plants.
- ...oh, and one more thing: Wouldn't it be fun to "partner" more closely with Microsoft, HP and Dell, working on x86 developments, schedules and... pricing?
A lively discussion ensues. Imagine solving many of Apple's problems with a single sweeping motion. This would really make Cupertino the center of the high-tech world.
It's an interesting idea, but there will be obstacles, both cultural and legal.
The Coach goes first: "Knowing both of these companies more than a little bit, I can attest to the pride they have in their respective cultures. They're both disinclined to reconsider their beliefs in any meaningful way. Merging these two dissimilar groups, shedding unnecessary activities such as McAfee and the like would be dangerously disruptive to Apple's well-honed, cohesive culture. As a general rule, merging two large organization rarely succeeds... unless you consider merging airlines a success..."
Finally, the Consigliere speaks: "It's a tempting fantasy, it will mean years of work for my firm and many, many others, but as a friend of the company, as a past confidant of your departed Founder, don't do it. There will be too much legal trouble with the Feds, with competitors, with Intel partners. Most fantasies aren't meant to be enacted."
I won't dwell on the reality of the meeting: I made it up as a way to explain why Apple really has no choice other than submit to another cash phlebotomy, this time for an additional $60B. And, as with real-world phlebotomies, the procedure will treat the problem, but it won't cure it. With $30B from operations per quarter, the $60B lancing will have to be repeated.
Some read the decision to return gobs of cash to shareholders as an admission of defeat. Apple has given up making big moves, as in one or more big acquisitions.
I don't agree: We ought to be glad that the Apple execs (and their wise advisers) didn't allow themselves to succumb to transaction fever, to a mirage of ego aggrandizement held out by a potential "game changing" acquisition.
A final word on taxes. To return the additional $60B (for a total of $100B when including the ongoing program announced last year) through increased dividends and repurchased shares, Apple will have to borrow money.
Borrow? When they have so much cash?
Yes, thanks to our mangled tax code. As explained here, about $100B of Apple's cash is stored overseas. If repatriated, it would be "heavily" (read "normally") taxed. Like most US companies that have international operations, Apple plays complicated, entirely legal tax games that allow their international profits to be taxed at very low rates as long as the profits -- and the resulting cash -- stay outside Uncle Sam's reach. And thus we have the apparent paradox of borrowing money when cash-rich.
The benefit of these tax code contortions is difficult to explain to normal humans -- as opposed to legislators who allowed the loopholes.
All this now makes Apple a different company. Once a fledgling challenger of established powerhouses such as IBM, Microsoft or HP, it now makes "too much cash" and is condemned to a life of paying dividends and buying back shares -- like the old fogies it once derided.