LONDON -- With some luck, Apple (NASDAQ:AAPL) shareholders could be in for a cash windfall.
Activist hedge fund Greenlight Capital is taking legal action over the company's massive cash pile. It piles pressure on the company to return dormant cash to shareholders. Apple could boost its current share-buyback program, increase its dividend, or give away preferred stock to ordinary shareholders.
A nice problem to have
Apple's is a nice problem to have: It's generating cash faster than it can use it. So its cash mountain is growing: $137 billion, or $145 per share at the last count. That's over a quarter of the current share price.
Apple's growth has slowed from its former days, and it has become such a big cash machine that it just doesn't have enough investment projects to spend its money on. Goldman Sachs' analysts reckon it generates a free cash flow yield of around 10%. That's what's available to pay dividends. Investors receive only a modest 2% yield, and the rest adds to the pile of spare cash.
Apple has been squirreling much of this money away in overseas tax havens. About 70% of the funds are held offshore and would incur tax charges if taken back into the United States. At some point, it would make distributions expensive.
That's where Greenlight's clever wheeze comes in. Last year, it suggested that Apple should distribute $50 billion of perpetual preferred shares to existing shareholders, at no cost. The preferred stock would yield 4% a year, in line with Microsoft's 30-year debt, and be separately tradable.
It wouldn't involve any distribution of cash: In effect it would be leveraging up Apple's strong balance sheet. It's a bit of financial wizardry, but not one that would put the company in any danger, with the preferred stock coupon costing just $2 billion a year.
Greenhill thinks the company could distribute several hundred billions of dollars of such stock, worth hundreds of dollars per share.
Or not so clever
The financial trick is that the perpetual stock, if it were to yield 4%, would effectively be valued at a price-to-earnings multiple of 25. That works only if investors believe Apple will be around for eternity (more or less, depending on your choice of discount rate), and interest rates won't rise too much in that time.
Apple's directors rejected the proposal and at this year's annual meeting plan to abolish preferred stock from the company's charter. Greenlight's lawsuit simply aims to stop the company from bundling this issue up with a couple of other resolutions.
But with the spotlight on its cash pile, Apple said last week that it would look at ways to return cash to shareholders. The shares promptly rose by 3%. The bottom line is that there is value in Apple's balance sheet that the market is currently discounting.
Value or growth?
Greenhill Capital is a value-driven hedge fund with $6 billion under management. That's a different league from Warren Buffett's $75 billion, but there's one similarity: Greenlight's performance has been impressive, with a nearly 20% per annum return to investors since its foundation in 1996. It's one of Apple's top 100 shareholders, and Apple is its biggest single holding.
That this pressure is coming from a value investor speaks volumes about how Apple's business has matured. To such investors, the core value in the company lies in the "ecosystem" of integrated technology that has a loyal fan base.
But other investors put more weight on Apple's ability to innovate and disrupt existing technologies. That's what powered its share price up from $3.28 to $700 between 2003 and 2012. It won't repeat that achievement, but concepts such as Apple TV, or wearable technology -- the Apple smart watch -- could see the company enjoy another growth spurt.
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