While the talk over the last few months regarding Apple AAPL has revolved around the iPhone 6 and 6 Plus, it is obvious that the firm’s growth has slowed over the past several years. As my recent YCharts report on Apple shows, recent growth has been in the high single digit percentage range–a far cry from its heady growth a few years ago.

The slow-down in revenue growth has a myriad of causes, but in short, Apple’s primary market–smartphones–is maturing and has become more competitive. This revenue slow-down does not mean that Apple is not a successful and formidable competitor. It is, in fact, enormously successful and profitable, generating an enormous amount of cash from its iPhone franchise and related products. Surprisingly though, this prodigious capacity to generate cash flows represents a conundrum for Apple’s management and shareholders.

There are two assumptions implicit in discounted cash flow valuation models. First, they assume that a large proportion of the assets of the firm are actively utilized to generate the products and / or services that generate the company’s revenues. Second, they assume that all the cash profits generated by the company and not spent on investment projects are the property of the shareholders of the firm and can theoretically be distributed to them.

For Apple, neither of these assumptions hold.

Apple outsources production of its devices, so it need not spend much money on property, plant & equipment (PP&E); in the current parlance, Apple is “asset-lite.” Of the $39.51 of assets per share, roughly $25 worth (60%) is cash and investments–assets that do not directly contribute to the generation of Apple’s profits. Activist investor David Einhorn in fact likened all this cash to a pile of unused “inventory.” (See Einhorn’s presentation here.)

Source: Company statements, IOI Analysis

Carl Icahn has seized on the same point, and badgered the company into increasing its stock buyback program and paying out more in dividends. The catch is that while Apple is cash-rich from a financial statement perspective, it had to borrow money to meet Icahn’s demands. Apple generates a large amount of its profits overseas and this overseas cash is “stranded” in foreign bank accounts because the firm does not want to pay a massive tax bill upon its repatriation.

How massive is massive? According to Apple’s most recent annual statement, $137.1 billion in cash and securities are held by foreign subsidiaries. If the company brought all of this back at once–and assuming it paid a statutory 35% tax–it would owe the Department of the Treasury $48 billion. That is a prospective tax bill more than two and a half times the median market capitalization of S&P 500 firms!

Apple’s Conundrum

Like any innovator, Apple is facing a conundrum. As its primary market matures, it is running out of ways to invest its shareholders’ capital so that it compounds quickly going forward. Added to that conundrum is the additional problem of “stranded” international profits. There are a few things it could do.

It could buy a foreign firm. In this way, Apple invests its cash overseas, avoids U.S. repatriation taxes, and boosts growth (assuming a successful acquisition). Microsof MSFT took this tact when it bought Nokia’s NOK handset business; tax considerations probably also came into play in General Electric’s GE purchase of French Alstom’s business.

There are a few problems with this tact. First, Apple is the classic example of a “Not Invented Here” company. Its largest acquisition has been Beats headphones–an accessory to its product–and its most important acquisitions have been small companies that provide subsystems that are incorporated into Apple products (a good example of which is its acquisitions of semiconductor designers). From a corporate culture perspective, it is hard to imagine Apple going this route. And even if it did, what the heck would it buy? $137 billion is a great deal of capital to try to allocate and allocating it well is another story entirely. Sony’s SNE total market capitalization is only $25 billion and Samsung’s SSNLF is around $140 billion. Even assuming that it could clear Japanese or Korean protective regulatory roadblocks (it couldn’t), it’s not clear that buying either of those firms would end up providing Apple shareholders a good return on their investments.

Apple could–as Mssrs. Einhorn and Icahn would like–return cash to its owners in the form of dividends or share repurchases. In terms of financial theory, this is the right answer; accumulated corporate wealth that cannot be effectively invested should be paid out to shareholders, who might be able to invested more profitably.

But as discussed above, bringing all its foreign cash home to distribute to American shareholders carries with it an enormous tax liability. Einhorn devised a financial engineering scheme for Apple to issue preferred shares (“iPrefs”) that he claimed would allow Apple shareholders to have their cake (receive a fat dividend check) and eat it too (retain cash overseas). His idea, while undoubtedly creative, was branded “financial alchemy” by one of the most knowledgable valuation specialists in the world, NYU professor Aswath Damodaran, and Einhorn eventually gave up on the iPrefs idea and trimmed his holdings of Apple. Icahn continues to clamor to be written a bigger dividend check, but unless Congress passes another overseas profit repatriation tax holiday (as it last did in 2004), Apple will have to issue more debt if it doesn’t want to saddle its shareholders with a tax bill large enough to buy nearly three
S&P 500 companies.

Apple broke new technological ground with its portable electronic devices and has changed the face of computing forever. Its long-term shareholders have profited handsomely from Jobs’ vision and Cook’s stewardship, but how the company handles its transition from being the first mover to being another competitor in a mature market will make a big difference to its owners going forward.