Too much cash is bad
Too much is too bad is what we have known for long. But we thought cash was an exception for there isn't diminishing marginal utility here.
It looks like too much of cash can also be a problem. As of now cash with Apple is at about $140 billion, that's a staggering number. The problem of plenty is quite unique indeed.
That is exactly what has become one of the problems Apple is facing today. From becoming the most valuable company in the world to becoming not the most valuable company, the journey of its value has been quite interesting. Take a look:
The market value down from about $650 billion to about $440 billion. That is $210 billion marked down in just 6 months. What is going on here? The world is divided. There are those who swear by that name, Apple and have all sweet stories to talk about; and there are those who say that all that rises has to fall someday, laws of nature. And there are those who are clearly not happy with $210 billion loss. These are the shareholders who think that Apple is worth much more and market is stupid to act the way it has. Their solution for fixing the problem is efficient use of cash. They think that market is discounting the value of cash held by Apple and once this is resolved the value will restore.
The business
Before we dwell on to this we should have a look at Apple's business. It is currently operating without any meaningful capital and generating about $156 billion of revenue, about $55 billion of pre-tax operating income and about $42 billion of free cash flows. It's one crazy business model, defying all reasoning. Hardly any input, but output is plentiful. It has been a cash-generating machine so far.
Will this continue? Operating margins are falling. Competition is increasing. The fight between Android and iOS is inevitable. Samsung is gaining momentum. There are a number of other players who want a share of the pie. The road is only getting bumpier.
The challenges
For Apple there four important challenges to consider: 1) To maintain the operating margin; 2) To maintain or increase the market share of its existing products, iphone and ipad in particular; 3) To grow its business with innovation; 4) To find effective and efficient ways to use excess cash.
I don't want to predict how Apple is going to handle its first three challenges. It is the last one I want to talk about.
Back to cash
Let us come back to those who feel Apple is currently undervalued and will increase in value once cash is properly dealt with. As small investors, one cannot do much, except bark in agony or excitement. But they can always piggyback on someone who is more powerful and willing to fight. David Einhorn is giving his shoulder to all those weak investors.
The preferred stock proposal, or the game
Einhorn wants Apple to issue a new class of preferred stock that will pay a 4% dividend in perpetuity, which he says will create value unlocking for Apple. He argues that for every $50 billion of preferred the value will increase by about $32 per share. He prefers $500 billion of preferred so that $320 per share value is unlocked.
This sounds interesting, but not realistic, especially if you are willing to recognize the difference between value and price. You can change value by increasing cash flows, or by increasing growth in cash flows, or by making cash flows safer, i.e. more certain than before. I don't see this happening when preferred is issued by Apple. A $4 dividend preferred should appropriately trade at par, not more, not less.
As for the price, we don't know what is the right price for the stock. The current price of $466 may be low, if we consider that the current revenue growth, margins and cash flows will continue; may be high if we consider that revenue, margin and cash flows will be affected going forward. In short, we don't know what is the correct price for Apple.
The stock price of Apple has about $140 of cash which is valued as it is at carrying value and about $326 of operating assets. The debate is related to this $326 per share: whether this is too low or too high for Apple. Let's not confuse this with cash.
If Einhorn feels that Apple is significantly undervalued currently, issue of preferred stock does not sound any logical solution. If his valuation of Apple is correct, eventually market will catch up with his value. To see how, just see the financial performance of Apple going forward. If Apple continues to perform better, its value will go up. There is immense case for Einhorn here to increase his stake in Apple when its price is falling. Why does he want it to go up when he knows that it is undervalued?
If he is not sure of his assessment of true value of Apple and simply wants to make use of his position as a significant shareholder, he is not trying to unlock value, but price. We hope that he knows it.
On the contrary, if Einhorn is successful in unlocking price of Apple stock, and the operating performance continues to slide in future, price will come down to catch up with Apple intrinsic value. If this were so, he would have only created a quick-exit-way for the shareholders by unlocking price. Those who don't exit, will suffer.
The moral of the story
Temporarily you can cheat markets by playing some games. However, over time markets will recognize the true worth and catch up.
Again to cash
Interestingly, Einhorn does not want Apple to part with its cash. Both the management and the board have forgotten the fact that when cash can be better used by shareholders, it should be handed out back to them. Paradoxically, Einhorn is backing management on this when they have failed to use the cash in an effective way.
A substantial amount of that cash is kept in different parts of the world, roughly about $85 billion, which will attract some additional tax if it is to be repatriated to the US.
It is no-brainer that so far Apple has not found effective and efficient ways of using excess cash. Since Apple is holding cash which belongs to its shareholders, the management and the board have a duty to deal with cash in a manner that pleases all shareholders.
The choices available are: reinvestments in the business, cash dividends, stock buy-backs and acquisitions. In the absence of reinvestments, and lest the cash is lost on bad acquisitions, the shareholders would want the cash be returned to them, rather quickly.
As I see it the most efficient way of returning cash and yet please all shareholders is through buy-backs. This is with a caveat that in general, stock buy-backs are not good if the current stock price is substantially higher than true worth of the business.
A fair game
Let us say, $100 billion (or about $100 per share) of buy-backs is done. It should please all groups of shareholders:
The Apple-all-the-way-shareholders will get to reject the buy-back and gain increased ownership and per-share earnings.
The no-Apple-shareholders will be able to accept the buy-back, receive cash which is more than market price (otherwise buy-backs won't work), and exit Apple.
But this proposal is not for the shareholders who want to exit but not at the buy-back price because they feel that the price is substantially low compared to its true worth. Well, that thinking is conflicting. They will have to wait for the market to catch up, or better yet, the preferred game could, but not certainly, help them.
Interesting times
Apple is undoubtedly one of the most widely followed stocks in the world. Everyone wants to know where it is headed and what it will do with its cash.
If I knew the right answers I would have created either substantial long or short positions and made money. Unfortunately, that is not to be.
But I do wish Einhorn well.
Too much is too bad is what we have known for long. But we thought cash was an exception for there isn't diminishing marginal utility here.
It looks like too much of cash can also be a problem. As of now cash with Apple is at about $140 billion, that's a staggering number. The problem of plenty is quite unique indeed.
That is exactly what has become one of the problems Apple is facing today. From becoming the most valuable company in the world to becoming not the most valuable company, the journey of its value has been quite interesting. Take a look:
The market value down from about $650 billion to about $440 billion. That is $210 billion marked down in just 6 months. What is going on here? The world is divided. There are those who swear by that name, Apple and have all sweet stories to talk about; and there are those who say that all that rises has to fall someday, laws of nature. And there are those who are clearly not happy with $210 billion loss. These are the shareholders who think that Apple is worth much more and market is stupid to act the way it has. Their solution for fixing the problem is efficient use of cash. They think that market is discounting the value of cash held by Apple and once this is resolved the value will restore.
The business
Before we dwell on to this we should have a look at Apple's business. It is currently operating without any meaningful capital and generating about $156 billion of revenue, about $55 billion of pre-tax operating income and about $42 billion of free cash flows. It's one crazy business model, defying all reasoning. Hardly any input, but output is plentiful. It has been a cash-generating machine so far.
Will this continue? Operating margins are falling. Competition is increasing. The fight between Android and iOS is inevitable. Samsung is gaining momentum. There are a number of other players who want a share of the pie. The road is only getting bumpier.
The challenges
For Apple there four important challenges to consider: 1) To maintain the operating margin; 2) To maintain or increase the market share of its existing products, iphone and ipad in particular; 3) To grow its business with innovation; 4) To find effective and efficient ways to use excess cash.
I don't want to predict how Apple is going to handle its first three challenges. It is the last one I want to talk about.
Back to cash
Let us come back to those who feel Apple is currently undervalued and will increase in value once cash is properly dealt with. As small investors, one cannot do much, except bark in agony or excitement. But they can always piggyback on someone who is more powerful and willing to fight. David Einhorn is giving his shoulder to all those weak investors.
The preferred stock proposal, or the game
Einhorn wants Apple to issue a new class of preferred stock that will pay a 4% dividend in perpetuity, which he says will create value unlocking for Apple. He argues that for every $50 billion of preferred the value will increase by about $32 per share. He prefers $500 billion of preferred so that $320 per share value is unlocked.
This sounds interesting, but not realistic, especially if you are willing to recognize the difference between value and price. You can change value by increasing cash flows, or by increasing growth in cash flows, or by making cash flows safer, i.e. more certain than before. I don't see this happening when preferred is issued by Apple. A $4 dividend preferred should appropriately trade at par, not more, not less.
As for the price, we don't know what is the right price for the stock. The current price of $466 may be low, if we consider that the current revenue growth, margins and cash flows will continue; may be high if we consider that revenue, margin and cash flows will be affected going forward. In short, we don't know what is the correct price for Apple.
The stock price of Apple has about $140 of cash which is valued as it is at carrying value and about $326 of operating assets. The debate is related to this $326 per share: whether this is too low or too high for Apple. Let's not confuse this with cash.
If Einhorn feels that Apple is significantly undervalued currently, issue of preferred stock does not sound any logical solution. If his valuation of Apple is correct, eventually market will catch up with his value. To see how, just see the financial performance of Apple going forward. If Apple continues to perform better, its value will go up. There is immense case for Einhorn here to increase his stake in Apple when its price is falling. Why does he want it to go up when he knows that it is undervalued?
If he is not sure of his assessment of true value of Apple and simply wants to make use of his position as a significant shareholder, he is not trying to unlock value, but price. We hope that he knows it.
On the contrary, if Einhorn is successful in unlocking price of Apple stock, and the operating performance continues to slide in future, price will come down to catch up with Apple intrinsic value. If this were so, he would have only created a quick-exit-way for the shareholders by unlocking price. Those who don't exit, will suffer.
The moral of the story
Temporarily you can cheat markets by playing some games. However, over time markets will recognize the true worth and catch up.
Again to cash
Interestingly, Einhorn does not want Apple to part with its cash. Both the management and the board have forgotten the fact that when cash can be better used by shareholders, it should be handed out back to them. Paradoxically, Einhorn is backing management on this when they have failed to use the cash in an effective way.
A substantial amount of that cash is kept in different parts of the world, roughly about $85 billion, which will attract some additional tax if it is to be repatriated to the US.
It is no-brainer that so far Apple has not found effective and efficient ways of using excess cash. Since Apple is holding cash which belongs to its shareholders, the management and the board have a duty to deal with cash in a manner that pleases all shareholders.
The choices available are: reinvestments in the business, cash dividends, stock buy-backs and acquisitions. In the absence of reinvestments, and lest the cash is lost on bad acquisitions, the shareholders would want the cash be returned to them, rather quickly.
As I see it the most efficient way of returning cash and yet please all shareholders is through buy-backs. This is with a caveat that in general, stock buy-backs are not good if the current stock price is substantially higher than true worth of the business.
A fair game
Let us say, $100 billion (or about $100 per share) of buy-backs is done. It should please all groups of shareholders:
The Apple-all-the-way-shareholders will get to reject the buy-back and gain increased ownership and per-share earnings.
The no-Apple-shareholders will be able to accept the buy-back, receive cash which is more than market price (otherwise buy-backs won't work), and exit Apple.
But this proposal is not for the shareholders who want to exit but not at the buy-back price because they feel that the price is substantially low compared to its true worth. Well, that thinking is conflicting. They will have to wait for the market to catch up, or better yet, the preferred game could, but not certainly, help them.
Interesting times
Apple is undoubtedly one of the most widely followed stocks in the world. Everyone wants to know where it is headed and what it will do with its cash.
If I knew the right answers I would have created either substantial long or short positions and made money. Unfortunately, that is not to be.
But I do wish Einhorn well.
No comments:
Post a Comment