The Apple (AAPL +0.33%) shareholder debate about what it should do with its $137 billion in cash rages on. This time, it's coming from Apple bull-turned-activist David Einhorn, the CEO investor extraordinaire behind Greenlight Capital, urging Apple shareholders to vote against a proposal that eliminates the company's ability to issue preferred stock.
Einhorn believes that for every $50 billion in preferred stock Apple issues, it will "unlock" an additional $30 billion -- or $32 per common share. Assuming Einhorn is correct, with Apple's current market cap hovering just under $450 billion, such a move would generate less than 7% of value to shareholders. If Apple were to issue more preferred shares beyond $50 billion, Einhorn feels additional value can be unlocked with each issuance.
Call me old-fashioned, but this sure doesn't sound like a lot of return relative to the amount of media attention its receiving. Not to mention, a $50 billion "investment" that Apple makes in the form of returned capital that only "unlocks" $30 billion in value doesn't seem like a great investment proposition. I'm looking at this from the perspective of an investment, because returning $50 billion takes away Apple's potential to invest that capital. Not to mention it will increase Apple's future liabilities.
There's a big difference
The confusion around this saga boils down to the key difference between value and price. These two words are not synonymous and shouldn't be interchanged within the scope of investing. Renowned valuation theorist Aswath Damodaran, professor of finance at NYU, believes no value will be created as the result of issuing preferred stock. His reasoning is simple: You cannot create value out of nothing, and giving preferred stock to common stockholders constitutes a "nothing" act. To Damodaran, the only way a company creates value is either by increasing cash flow from existing assets, reducing the risk in existing cash flows, improving its tax benefit, or by growing more efficiently. Unfortunately, none of what Einhorn proposes falls under these parameters.
However, Damodaran goes on to say that price may be affected positively as a result of Einhorn's proposal. Under this scenario, Damodaran argues that not only must you believe that Apple is undervalued, but you also have to believe that the market is undervaluing the stock because it's not giving full credit for its cash balance or its ability to generate large cash flows. Investors must either distrust Apple's ability to make sound investment decisions, or fear that cash is being hoarded and will never see the light of day.
Not the best solution
Apple probably isn't being discounted because it has a lot of cash on its books and shareholders are "punishing" the stock. If Apple really wants to return more capital to shareholders, it can simply increase the common share dividend, which would drive more income oriented mutual funds into the stock, or it can issue a larger-scale buyback. The fact of the matter is that investors are more concerned about Apple's long-term future. The company has shown increased evidence of margin pressure over the past few quarters, spooking investors that unit growth is coming at the expense of profits. Cannibalization is real threat to Apple's margins in the near term, especially if a lower-cost iPhone gets thrown into the mix.
The other huge factor likely playing into Apple's seemingly low valuation is that it lost its "revolutionary" premium since Steve Jobs' passing. I can understand a temporary loss of faith from investors, but let's not lose sight of the fact that this is the company that changed the music industry, went on to revolutionize the smartphone industry, and then gave birth to the tablet industry.
That said, the market may be underestimating Apple's future ability to revolutionize another industry and create a new paradigm. Do investors really think Apple is out of ideas to create real value? I'm pretty sure those investors are going to be mistaken in the years ahead.
