iPrefs Aren't the Answer for Apple

On Thursday, hedge-fund manager David Einhorn of Greenlight Capital held an unusual conference call to discuss the merits of his proposal for Apple (NASDAQ: AAPL  ) to issue preferred stock (or "iPrefs", to use Einhorn's words). While Einhorn's proposal is innovative, it dances around the core problem: Apple has more cash than it can usefully invest. Einhorn suggests that Apple could issue preferred shares instead of returning its cash to shareholders. However, rather than conceding the point to Apple's board of directors and management team, shareholders should demand that the company actually return its excess cash.

The background
Earlier this month, Einhorn claimed that Apple's hoarding of cash reflects a depression-era mentality. As of December, Apple has amassed a $137 billion cash stockpile, the vast majority of which has been accrued in the last 2.5 years. By contrast, Apple CEO Tim Cook recently countered that the company promised to return $45 billion to shareholders over three years through dividends and share repurchases, and spent $10 billion on capital expenditures last year. Cook argues that these uses of cash refute the idea that Apple has a "Depression-era mentality."

Leaving aside the semantics, the problem with Tim Cook's argument is that Apple generated over $50 billion in operating cash flow in its most recent fiscal year, and nearly $24 billion last quarter alone! Thus, while Apple's investment and cash return plans would be generous for almost any other company, these initiatives will only slow the rate at which cash accumulates. The $137 billion already on Apple's balance sheet will remain there.

The proposal
This leads to the key problem with Einhorn's proposal. While Einhorn chastised Apple for keeping so much excess cash on its balance sheet, under his proposal Apple would still leave its war chest untouched. Instead, the company would issue "iPrefs" -- preferred stock -- to existing stockholders (at no charge). Einhorn's proposal calls for the preferred shares to be worth $50 each, and yield 4% (a $2 annual dividend).

According to Einhorn, issuing one iPref for each Apple share would cut Apple's EPS by $2, and reduce the stock price from $450 to $430, but in return shareholders would get $50 of preferred stock, which they could sell. So the transaction would create $30 of value. Einhorn claims that the company could even issue five iPrefs for each existing share, unlocking $150 per share in value.

Keep it simple
However, Apple would better serve its shareholders by returning its excess cash.  As my Foolish colleague Evan Niu pointed out on Thursday, Apple could attract lots of value investors if it initiates a clear plan to do so. Many analysts have blamed Apple's recent stock swoon on the exit of growth investors from the stock. If Apple can reignite its growth later this year, these investors might return. However, in the meantime Apple should undertake a larger share buyback (to attract value investors) or a dividend boost (to attract income and value investors alike). These policies might entail drawing upon the $137 billion in Apple's bank account, but they would benefit shareholders more than Einhorn's "iPrefs" by bringing new investors into Apple.

There's no doubt that Apple is at the center of technology's largest revolution ever, and that longtime shareholders have been handsomely rewarded with over 1,000% gains. However, there is a debate raging as to whether Apple remains a buy. The Motley Fool's senior technology analyst and managing bureau chief, Eric Bleeker, is prepared to fill you in on both reasons to buy and reasons to sell Apple, and what opportunities are left for the company (and your portfolio) going forward. To get instant access to his latest thinking on Apple, simply click here now.


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  • Report this Comment On February 24, 2013, at 11:20 AM, stefna wrote:

    Einhorn blows the call on AAPL... screams and bashes gas cans together to regain alpha status.

  • Report this Comment On March 07, 2013, at 10:12 PM, JamesHoJuice wrote:

    I have to agree partially on this article and disagree on it at the same time.

    The fact that Apple should return excess cash as a better option than iPrefs is by all means very, very accurate.

    But I can see how and why Einhorn came out with iPrefs.

    One of Apple's greatest barrier to returning cash are the tax considerations, and stuffing in a financial instrument is the best compromise Einhorn can think of which he believes Apple will compromise.

    And although shareholder's may want to demand their cash back, there is a contrast in what the management's pay package will drive them to do and what is best for most shareholders.

    iPrefs actually form a great compromise for the fact a majority of shareholders are institutions. That would impede them from wanting pure cash as it will result in them requiring an instant rebalancing in their portfolios just because of their archaic mandates. I doubt the institutions will endorse a return of cash.

    So in the ideal world, shareholders should demand for a return of excess cash.

    But from a psychological standpoint, I sincerely doubt so that this request will pass through with the institutions, where holding cash is seen as a folly (another oxymoron)

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