rc3.org Strong opinions weakly held

http://online.wsj.com/article/SB124405584326082111.html

Just a hypothesis.

Posted by Jacob Davies on 26 April 2010 @ 7pm

A long time ago in a galaxy far away, when companies made money they paid something called dividends to their owners. Some time in the 1960s a new theory was introduced that it made more sense for the companies to stop paying dividends and reinvest the money in improving company operations. Stock prices that were once based on the flow of dividends were now based on the likelihood that future revenue growth would lead to a higher stock price.

When industries are growing and can benefit from capital spending, this makes perfect sense, but when industries are mature, this money has to go somewhere. The company could pay larger dividends, but this is out of fashion. More frequently the CEO cuts a check payable to his own order and cashes it. Otherwise, the money just builds up, and that’s what we are seeing.

Now, cash on hand can be a good thing. I remember when IBM issued a billion dollars worth of bonds, the largest private issue ever, and a lot of the money went into building their PC business and upgrading their operations. (They made their own ICs back then.) That was then American business was about return on physical capital. Those days are gone.

Right now, most physical capital spending is in China. The kinds of things Americans tend to make are low capital. Think about it. The big capital expense for the iPad was the software. The Chinese built the production facilities, not Apple. Our fastest growing industry is finance. How much does it cost to build a derivative, even with $1000 an hour lawyers, compared with, let’s say a steel mill or a few miles of train track?

I suppose if Apple ever wanted to get back into manufacturing, they could just start writing checks and building factories again, but I don’t see this a likely. The money really isn’t there. Everyone knows how to build a computer factory. There isn’t anything innovative there. It would be like a lemonade stand. Lemons cost this, ice costs that, a pitcher and a stand cost such and such. Throw in a minimum wage and compute the ROI.

The big downside is that Apple is now an attractive take over target, save for its astronomical stock price, but Apple isn’t the only company with cash piling up. I’m sure that, even now, financial guys are sitting there with spreadsheets watching the 10-Qs. When the stock price sags, they’ll strike. Who wouldn’t want to buy a billion dollars for a mere $850 million? Hey, and they even throw in a company you can milk dry as a freebie. I doubt that Apple will be the first victim, but I’ve got my newsreader tuned.

Posted by Kaleberg on 26 April 2010 @ 9pm

I imagine that we’ll see companies repurchasing their own stock if the prices go down in order to avoid that scenario.

Posted by Rafe on 26 April 2010 @ 9pm