iPrefs: The Product Apple Didn't Know It Wanted

Steve Jobs once said, "A lot of times, people don't know what they want until you show it to them." Apple (AAPL -0.57%) has always innovated on this premise. It has brought the tech giant much success. But lately, success has been hard to come by; the stock has plummeted 40% from an intraday high of $705 last September.

The sentiment bubble
Apple has a problem that every company wants -- a cash hoard of $137 billion, but no epic idea of what do with it. I've done my part as a shareholder; the company now has all of my routing numbers. I'm still waiting to hear back. But in the meantime, here comes David Einhorn, the outspoken hedge-fund manager at Greenlight Capital. He's got a few ideas of his own. One in particular is called "iPrefs," which has brought him much scrutiny.

I never wanted to like the idea. My loyalty to Apple was too strong. Even CEO Tim Cook called it "a silly sideshow." I agreed. Besides, Apple didn't grow to become the largest company in the world with clueless management. Therefore, who's this guy Einhorn to make cash-use demands? In a recent article, I talked about how I felt he was doing more harm than good. That article prompted an exchange. Einhorn reached out to me and we discussed Apple's current situation -- more specifically, how the company is being appraised by the market.

It requires, however, much more than just a cursory view of Apple's status to appreciate the company's $137 billion cash pile in relation to the ebb and flow of market sentiment. Consider this: From January 2009, when the stock traded at $82.33, to its recent intraday high of $705, shares gained 756% in just four years. That's an absurd average of almost 20% per month for 44 consecutive months. Yet, the P/E ratio never fully reflected confidence -- dropping from 35 to 9, where it is today. But the cash kept rising. What's the problem? The company was carrying too much cash.

The market punished Apple for this by discounting the cash and its future value. By contrast, Texas Instruments (TXN -1.23%), which has 43% more debt than it does cash, is making new 52-week highs. I've been scratching my head around this for quite some time. This is despite struggles with declining revenue. There's no way TI deserves a higher P/E than Qualcomm, much less Apple. Same goes for IBM (IBM -0.89%), which has $33 billion in debt and only $11 billion in cash. It's not a great ratio. But the market forgives IBM's highly levered balance sheet because the company is seen as "shareholder-friendly." For that matter, IBM's 85% return on equity is one of the best on the market.

Coming to terms
There are two lines of thinking here -- what management sees and what the Street wants. You can chose to focus on the unit figure misses, but management sees an operation that is posting record revenue of $54 billion and sales of more than 75 million iOS devices in one quarter. There's no urgency to change. Despite the lost "mojo," the company still makes tons of money. And Cook deserves credit for growing robust free cash flow. Even Einhorn can't dispute that.

However, investors have suffered. But the company's doing well. The disconnection is glaring. But if Cook is truly sincere in saying "I don't like it either, neither does the board or management," then he needs to make a phone call to Einhorn. What's the benefit of gaudy sales performances, if the market doesn't care? It causes resentment. But Cook also said Apple's "focused on the long term." I wouldn't want it any other way. But I think the company owes it to investors to consider all options.

Besides, the $2 per year "permanent preferred" dividend in iPrefs presents a win-win scenario. It will reverse the damage done to the stock, while allowing the company to execute its long-term vision as it sees fit. And it does not signal the end of Apple's great ideas. Instead, it signals the beginning of the next phase of Apple's growth.

Change we can believe in
Let's substitute loyalty with logic. And despite the barrage of headlines making this out to be Einhorn vs. Apple, it's truly about what's best for shareholders. Einhorn took up the fight for investors at a considerable expense to his fund. And the irony with iPrefs is that it truly belongs in Apple's product portfolio -- it's just as innovative. And as an investor, I didn't realize I needed it until it was shown to me.