As far as Apple (NASDAQ: AAPL ) bulls go, hedge fund superstar David Einhorn is about as vocal as they come. The fund manager has long been extremely bullish on the Mac maker's fundamental business and is a notable investor in the company with over 1.3 million shares. He's also making headlines today because his company, Greenlight Capital, is suing Apple.
What's going on?
Here's an idea
Einhorn's beef with Apple is one that investors have heard before: the company's capital allocation strategy needs to be improved. Just yesterday there was talk from mutual fund guru Bill Miler about how a significant dividend increase could make the balance sheet a catalyst and send shares higher.
In order to address this problem, Einhorn made a suggestion to the company last year that could satisfy everyone, including Apple. The notion is to create a new class of perpetual preferred shares that would be distributed to existing shareholders at no cost to the company. Perpetual preferred stocks pay dividends indefinitely and have no maturity date. If Apple were to institute a healthy 4% yield on these shares, then that would be mighty tempting for value and income investors that can bank on those dividends.
At the same time, it wouldn't require any immediate capital outlay so Apple could maintain its current $137.1 billion war chest for all the strategic purposes that it's always hoarded money while also avoiding the need to bring cash home and pay repatriation taxes. In Einhorn's opinion, such a move would do wonders to unlock the value within the balance sheet for shareholders, rewarding them directly for Apple's tremendous success.
By Greenlight's estimates, every $50 billion of perpetual preferred shares that Apple distributes could unlock approximately $30 billion, or $32 per share, in value. At a 4% yield, each $50 billion block only costs Apple $2 billion per year. Compare that to the current $10 billion it pays out in dividends right now. Based on these figures, Einhorn believes Apple could easily "unlock hundreds of billions of dollars of shareholder value."
Five months ago, Apple rejected this idea outright when Greenlight brought it up. However, Apple has offered to reconsider the idea now. Where does the lawsuit come in?
Rallying the troops
Apple's annual meeting is around the corner (Feb. 27), and as such the company has recently distributed its proxy statement for the fiscal year. The company has proposed an amendment to its articles of incorporation, which includes the elimination of Apple's ability to issue preferred stock, which would effectively nullify Einhorn's idea.
Apple currently does not have a preferred share class, and says the board has no intention to issue preferred stock in the future. The last time Apple issued preferred shares was when Microsoft (NASDAQ: MSFT ) bailed out the company in 1997 with a $150 million investment. The software giant received 150,000 shares of convertible preferreds that it subsequently converted into a total of 18.2 million common shares between 2000 and 2001. At the peak, those shares would have been worth $12.8 billion (an 85-bagger), but unfortunately the company liquidated its position way back in 2003.
The issue is that this proposal is bundled with other changes involving majority voting for directors and establishing a par value for common shares, both of which are considered positive for corporate governance. Shareholders must vote on all three of these items with one vote, which Einhorn maintains violates the SEC's proxy rules. He is suing to have Apple unbundle these matters so that shareholders may vote for them separately.
As it stands, Einhorn is urging fellow Apple shareholders to vote against Proposal 2 due to the provision on preferreds. I'd encourage all Apple investors out there to review the information. Einhorn's letter can be found here (link opens PDF), and Apple's proxy is here (link opens PDF, Proposal 2 begins on page 39).
How Apple is like your grandma
In his interview on CNBC, Einhorn compared Apple's mentality to people who had lived through the Great Depression, including his own grandmother. Events like that cause lifelong trauma, and many who experienced it have a strong aversion to risk and tend to hoard cash. This was particularly true when Steve Jobs was alive.
When Jobs came back to Apple, the company was 90 days away from bankruptcy, and that greatly affected his attitude toward cash. He even ignored Warren Buffett's direct advice to repurchase shares or institute a dividend. Jobs continued to sit on it and those two initiatives wouldn't happen until Tim Cook became CEO.
To illustrate how cheap Apple is, Einhorn makes direct comparisons to Amazon.com (NASDAQ: AMZN ) . Both companies have similar P/S multiples (Apple at 2.6 and Amazon at 2). Einhorn even points out that Apple made over $20 billion in cash last quarter (likely referring to operating cash flow instead of net income), which is "more money than Amazon has made in its entire life." He notes he does not have a short position in Amazon, but was using the e-tailer to illustrate how cheap Apple is.
What it means for investors
For investors, there are a couple reasons why preferred shares would be different than common shares. Common stock is more volatile and correlates more directly with a company's earnings power, which can fluctuate over time. Preferred stock has a higher claim on company assets than common, and is assigned a par value per share that the dividend yield is based upon, making the shares similar to bonds in some ways.
The preferreds that Einhorn is proposing would be a positive sign for Apple as a proactive move to improve capital allocation. That could also lead to multiple expansion as its earnings multiples are extremely depressed right now.
There's no question that all that money isn't doing shareholders very much good right now. Braeburn Capital is the subsidiary that manages Apple's cash, and the media likes to incorrectly categorize it as a "hedge fund" because it makes for a good headline. In actuality, it invests in "the most conservative investments known to man" with "the goal of capital preservation" -- not the typical hedge fund goal. That's all according to Tim Cook, and Apple's SEC filings provide some detail. It's mainly Treasuries, agency securities, and corporate bonds.
I would highly prefer Apple to distribute some of that cash to me as an investor so that I could invest it in something more in line with my own personal goals, which don't include Treasuries.
Einhorn's preferred idea may not fly, but he's got a point: Apple needs to do something about its cash problem.
There are plenty of reasons why Einhorn is confident of Apple's underlying business, and we're on the same page. Eric Bleeker, CFA, and I have compiled numerous reports on Apple's opportunities and biggest advantages in the years ahead. We've just recently added two new bonus reports on where Apple's future growth will come from and how much room Apple has to grow in China. Get started by clicking here.