This week hedge fund manager David Einhorn, whose investmentÂ managementÂ firm owns more than 1 million shares of Apple (AAPL) stock, publicly urged the company to take more meaningful action on its ever-rising cash hoard of $137 billion. Since management is not really taking the matter very seriously,Â despiteÂ the fact that every dime of that $137 billion belongs to the shareholders, Einhorn has proposed an alternative idea to unlock shareholder value; issuing preferred stock to existing shareholders, at no charge, with a 4% perpetual dividend.
His thinking revolves aroundÂ theÂ idea that Apple shares are not adequately valuing the cash on the company’s balance sheet, andÂ issuingÂ preferred stock would actually boost shareholder valueÂ becauseÂ the new stock would have a quoted value in the market that Â investors could actually monetize if they chose to do so. Einhorn is saying that if implemented, Apple shares post-preferred issuance would be worth more than they are today (becauseÂ he does not think Apple common stock would fall by $100, the value of the preferred given out). In addition, the 4% dividend on the preferred stock would increase the company’s dividend obligationÂ by less than $4 billion per year, which would easily be covered by future free cash flow and not eat into theÂ currentÂ $137 billion cash balance.
So does this plan have merit? I think it does, but I would agree with many who say that it is an overly complicated solution to a relatively simple problem. That said, if Apple is unwilling to take more traditional steps for the benefits of shareholders (after all, Tim Cook and his team work for us), then an idea like this is worth considering (to be fair, since a large portion of Apple’s cash is overseas, repatriation tax issues complicate their possible strategies quite a bit).
Interestingly, today I read a post byÂ Aswath Damodaran, a well known finance professor at NYU, who argues that Einhorn’s idea would generate noÂ shareholderÂ valueÂ whatsoever. Â How he can make such a bold claim, to me, is quite odd. It is true that the idea right now is all theoretical, and there is not a way to know for sure how much theÂ marketÂ would value Apple’s common and preferred shares if such anÂ issuanceÂ was implemented, but DamodaranÂ equivocallyÂ statesÂ that value can not be created outÂ ofÂ thin air. Here is his exact quote:
“You cannot create value out of nothing and giving preferred stock to your common stockholders is a â€œnothingâ€ act, as far as the value of the company is concerned.”
This concept is along the lines of somethingÂ you are likely to find in a finance textbook. Damodaran would likely argue that a company is worth X, based on the discounted value of future expected cash flows, plan and simple, and slicing and dicing paper does nothing to change that.
I would respectivelyÂ disagreeÂ for a fairly simple reason. I believe that something is worth what someone else is willing to pay. You have probably heard people say that a lot in a wide variety of contexts. For instance, if you are selling your house, justÂ becauseÂ it is appraised for “X” does not mean that is what it is “worth.” It is only worth the amountÂ thatÂ a buyer isÂ willingÂ to pay you for it. Which is why real estate agents value their clients’ homes using “comps,” which are actual sale prices forÂ comparableÂ homes. Original asking prices, or appraised values, are not considered because they are not “real” prices.
The same is true of stocks. At any given time a share of stock is worth the market price, plain and simple. If Apple stock is trading at $470, as it is today, that is what you can sell it for. As a shareholder, that price represents its value to you. At thatÂ momentÂ youÂ canÂ either choose to own one share of Apple or $470 in cash. No other option exists.
Now, an analyst, or portfolio manager, or finance professor can do some number-crunching andÂ concludeÂ that theyÂ believeÂ Apple should be worth more than $470 per share (in fact, both Professor Damodaran and I agree that Apple is a bargain currently), but just because someone believes that to be the case does not make it true. In order for our opinions to be proved right, the market has to price the stock at that level. That is the only way we could ever actually sell our stock for a higher price.
Investing in a stock is making a bet that its market value will be higher in the future, affording usÂ theÂ opportunityÂ to sell our shares and make a profit. Professor Damodaran makes theÂ philosophicalÂ argument that price and value are not the same, but IÂ respectfullyÂ disagree. A share of stock is only worth what someone else isÂ willingÂ to pay and the price someone isÂ willingÂ to pay is the current market price.
So, back to the case of Apple. If the company took David Einhorn’s advice and gave investors $100 of preferred stock for free, for everyÂ shareÂ of Apple they owned, it is entirely possible that Apple common stock would trade above $370 (the current price less $100). We cannot prove that unless it actually happened, but it is a reasonable conclusion to draw based on Apple’s earnings power ($40 per common share in trailing EPS post-preferred issuance).
In fact, if Apple common sharesÂ fetchedÂ a 10 P/E, asÂ EinhornÂ projects, the stock would be $400 and shareholders would then own $500Â worthÂ of Apple securities ($400 common plus $100 preferred). Considering that they can now only get $470 for theirÂ shares, there would indeed be $30 per share of “value creation” for shareholders. Again, Apple stock is only worth what someone isÂ willingÂ to pay. That amount is the current price. no more and no less. For anyone to argue that no value would have been created for investors in thatÂ scenarioÂ seems illogical. Price and value are one and the same because there is no guarantee that anyone will ever beÂ willingÂ to pay you what you perceive the value of something to be (howÂ frequentlyÂ that occurs willÂ determineÂ how good of an investor you are).
I remember reading about a line delivered by Donald Trump inÂ 2007 when asked about his net worth. Here is the exchange:
Trump: My net worth fluctuates, and it goes up and down with the markets and with attitudes and with feelings, even my own feelings, but I try.
Ceresney: Let me just understand that a little. You said your net worth goes up and down based upon your own feelings?
Trump: Yes, even my own feelings, as to where the world is, where the world is going, and that can change rapidly from day to day …
Ceresney: When you publicly state a net worth number, what do you base that number on?
Trump: I would say it’s my general attitude at the time that the question may be asked. And as I say, it varies.
In this case Trump is using the sameÂ definitionÂ of value that Professor Damodaran seems to be using. Trump saysÂ his net worth is X. That is theÂ perceivedÂ value, which is why he thinks it can beÂ differentÂ based on how he “feels.” Of course, we know that netÂ worthÂ is a technical term. There is no perception involved. His netÂ worthÂ is theÂ amountÂ ofÂ money that would be left over if he were to sell all of his assets and repays all his debts. Plain and simple.
As for Apple, I am hopeful that Einhorn’s public challenge of Apple’s capital allocation policiesÂ kick-startsÂ some changes atÂ theÂ company. There is no doubt in my mind, and many are in agreement, that the current market price of Apple is largely discountingÂ the value of its massive $137 billion cash hoard. There is no other explanation as to why the stock current trades at aÂ trailingÂ P/E of only 7, especially when you compare it with other technology stocks.
Full Disclosure: Long shares of Apple at the time of writing, but positions may change at any time