It didn't take much for Wall Street to fall out of love with Apple (AAPL +2.08%). The company went from basking in investors' adoration to dodging tomatoes in a matter of months. It was just last September when the stock was hitting all-time highs. Fast-forward to today, and the stock is 30% lower, well within bear market territory. This has upset Apple bull-turned-activist investor David Einhorn, because he manages $6.5 billion worth of clients' money. When your fund owns over half a billion dollars' worth of Apple, it gives you the unique privilege of sparking a conversation that will get investors' attention.
Einhorn feels that Apple needs to address its stock price underperformance and "apply the same level of creativity used to develop revolutionary technology for its consumers to unlock the value of its strong balance sheet for its shareholders." The financial innovation Einhorn is after comes in the form of perpetual preferred stock in $50 billion increments yielding 4%. Einhorn believes each increment has the ability to "unlock" $32 per share, or about 7% at the time of this writing. Ultimately, Einhorn envisions Apple could distribute "several hundred billions" of preferred shares, potentially unlocking "hundred of dollars in value per [common] share."
Einhorn has effectively created a conflict between doing what's best for Apple versus its shareholders. Surprisingly, it's not always the same option.
51% a year
In three years' time, Apple's cash balance went from $39.8 billion -- which is less than its current $45 billion dividend and repurchase plan, mind you -- to over $137 billion last quarter. If $39.8 billion were invested and turned into $137 billion three years later, it would mean that the investment returned 51% a year on a compounded basis. Let that sink in for a minute. For a company with the size and scale of Apple to grow its cash balance that rapidly is truly an amazing accomplishment. Relatively speaking, Apple just saved up all this cash, of which $45 billion will be returned to shareholders, and investors are still complaining it's not enough? Just because Apple can technically afford to do more doesn't mean it's a good business idea.
Big ol' life jacket
Apple is a company that comes from humble beginnings. There were times along the way when the company was at high risk of bankruptcy. Now that Apple has hit it big, it's not surprising to see its conservative attitude toward its balance sheet. I think of Apple's cash as a hedge against a massive unforeseen risk -- a black swan, if you will. The sobering reality is that technology changes extremely rapidly, and could easily undermine an entire business model in an instant. In today's day and age, all it would take is a start-up fulfilling a largely unmet need in the market place to completely dismantle Apple's kingdom. Cash gives Apple the chance for another act. As long as Apple continues making aggressive business decisions that put a lot of weight on the success of a small product lines, I'm fine with its cash position being conservative. A risky balance sheet on top of an aggressive business practices would add substantially more risk to Apple's investment merit.
Stop being greedy, Einhorn!
As of Sept. 30, Einhorn's fund held a 9% allocation of Apple. A 30% decline on a 9% position equates to an overall loss of 2.7% for the entire portfolio. In the world of hedge funds, you're only as good as your last quarter, and I think it's pretty safe to say that Einhorn's last quarter wasn't one to write home about. Perhaps all this activism is merely a means to recoup losses on his investment? Assuming he has many clients that are likely breathing down his neck, he has to do something to save his own reputation.
I'm hoping Apple holds the line and doesn't get bullied by Einhorn, because his interests do not appear to be aligned with interests of Apple's business. Apple was wildly successful because it brought unmatched passion and energy into the development of its products. The longer Apple's management has to focus on corporate issues, the more it detracts Apple from doing what it does best, which is to create revolutionary products. If Apple can stick with this passion, I strongly believe shareholders will ultimately be rewarded.
