Greenlight Capital's conference call to discuss David Einhorn's proposal for Apple (AAPL) to issue preferred shares, is about to get underway. You can follow along at this address.
Apple shares are currently down $5.33, or 1.2%, at $443.52.
We're being the purpose is to “unlock value for all Apple shareholders.”
Einhorn comes on the call, thanks everyone for listening to how to “unlock significant shareholder value.”
Apple, he says, “are the leaders in innovation. Over the years they've done very well by exploring new ideas” and have ended with a pile of cash that reveals “a basic flaw in Apple's capital allocation.”
We don't know what their plans are and we don't need to know. The beauty of our idea is it lets Apple run their business. This is not complicated, it's merely unfamiliar. We think you will agree we are proposing the best solution for shareholders without impinging on Apple's plan. There are several common themes that explain the tech industry's cash hoarding. Tech companies like to know they can make acquisitions. In tech, innovation happens at light speed, and if tech companies run into trouble, Wall Street can't be counted on, so you need a rainy day fund that will get you through tough times. Historically, some of the biggest repurchases of shares are by companies with overvalued stocks. Dell was one of the biggest buyers of shares at a time when its stock was expensive. Microsoft has shown that one-time dividends and share repurchases are not enough to drive value in the face of declining innovation. Occasionally, a US company finds a way to repatriate, but generally foreign cash accumulates. In 2004, the US had a one-time tax holiday. Apparently, many companies think it can happen again. The anticipation of a tax holiday allows companies to tell shareholders that bringing back cash would be a waste. In reality, no CFO wants to bring back cash today only to find there's a tax holiday next year. For companies to have all-cash balances is inefficient. The market assigns a discount for this kind of overly conservative long-term capital management. The market not only discounts the cash on the balance sheet but also the multiple of the stock. One can find convenient examples of dividends and repurchases being beneficial, but failing to return cash generally results in a lower valuation. IBM and Texas Instruments are examples of shareholder-friendly companies. Dell has the lowest P/E of all. Dell's go-private effort shows the disingenuous nature of hoarding cash. Last year we sold the stock. Michael Dell probably didn't mind, it provided him an opportunity. Dell's cash-rich balance sheet will become highly levered. When its their money, they don't need so much cash. Let's debunk the myth of cash hoarding: if you distribute cash to shareholders, doesn't it mean you're no longer a grow company? Doesn't it also mean that if you're keeping it on the balance sheet for years? When a business doesn't require every penny to be reinvested, it doesn't mean the business can't grow. It just means growth is limed by something other than the cash. Let's look at Apple. War Chest? More like a war vault. $137 billion and growing rapidly. More than $94 billion is currently offshore. Apple trades at an exceeding low P/E. when two thirds of your market cap is in cash, it means one third of your business is in the lower-growing cash market. Apple's balance sheet is all equity. This means the balance sheet is all supported by the high-cost equity capital. Apple can unlock value by either employing cash productivity, returning cash to shareholders, or reducing the cost of equity. T do a one-time dividend or a large repurchase, its good to look at cash available. With $94 billion in foreign cash taxed at 35%, there is $61 billion available to be brought home. With $43 billion domestically, there is $104 billion available. We made some assumptions about a reserve, $20 billion. This should leave Apple well positioned to continue its business plan and make acquisitions. We believe Apple is highly debt-averse. Even $20 billion is probably not realistic, but it serves as an example. A one-time dividend would come out to $89 per share. If the market is giving Apple no credit for the cash, the full $89 value would be realized. There's no way to know for sure how much value the market is giving Apple for the cash. The market might reward Apple with a higher P/E multiple. If it is done grudgingly, the market might not reward Apple. We saw this with Microsoft's one-time dividend. Lets look at a second option, a tender of $600 per share for a one-time repurchase of 15% of shares, leaving 850 million shares outstanding. You'll get a combined value of $89 per share. In the next alternative, Apple could keep its current cash balance, frozen, and use future cash to fund repurchases. We assume Apple uses its domestic cash until it runs out. Here's what it looks like over three years: when apple pays out 100% of futu cash, it depletes domestic cash sometime in 2014. Then it needs to repatriate, which causes its tax rate to go up. It would signal more shareholder-friendly position. It is difficult to estimate the incremental value. We think Apple shares would immediately re-rate by 10-20% as its earnings rise with a lower share count. We assume an immediate 17% stock-price bump, with 15% following returns. Another possibility is an immediate dividend increase. The reality is that equity investors value companies by a variety of means other than just dividend yield. The equity market is more interested in Apple's total earnings: will they beat earnings estimates, what new products will they introduce. These issues will likely trump a dividend yield. Now, lets take step back and consider Apple's history. Apple was once In a hole so deep it had to go to Microsoft for money. But when the third of the company is in cash, it requires the sort of attention dedicate to running the rest of the business. Like Apple, we agree one should take a conservative approach to managing cash. Fortunately, that's not always at odds with innovation. Under no circumstances does Apple want to put itself in danger. We have a solution for unlocking value for shareholders. We have developed a brand new capital markets product. Here's the product that Apple doesn't yet know it needs. Introducing, iPrefs. What is a perpetual preferred stock? A stock that pays dividends forever. It has a base value of $50 and pays a dividend of $2 per year. Apple can redeem them for face value, but shareholders should not anticipate getting the face value. They should expect to receive 50 cents per quarter, every quarter, forever. We thought distributing $50 billion would be a good number. We suggest $47 billion, or 1 iPref per common share. The idea is to give Apple a way to start out. There may be initially more demand for iPrefs than can be supplied. There are very few high-quality issuers that approach Apple's quality. IBM's paper yields the same as Microsoft's. We think Apples should at least trade as high. It should over an 80-basis-point spread to 30-year treasuries. Over time, the iPrefs should be highly liquid. We expect the market to accept the iPrefs as a premium quality instruments. To receive a 4% from someone who can't fail is quite exciting. And we know the company that produced iTunes knows how great it is to buy CDs. Once the iPrefs are distributed, the annual dividend payment by Apple is $1.9 billion. Current profit estimates would be reduced by $2 annually. This means the new Apple earnings would be $43 [this year]. That would reduce the common stock price to $430. But it adds value of $50, for $480, which is $30 higher than the current stock price. While iPref distribution combined with existing dividend would exceed existing cash flows, we think it could fund it through the existing domestic cash balance and future cash flow without ever depleting the cash balance.
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