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Monday, February 25, 2013

Apple vs. Greenlight: deconstructing the battle over preferred stock Hedge fund manager David Einhorn makes the case for ”iPrefs“ yielding $0.50 a quarter.



"Mo Money Mo Problems," in the immortal words of Notorious B.I.G.
Apple has more money than many nations, so it's only natural to expect the $137 billion cash and investment hoard to attract some controversy. Maybe even a few lawsuits.
That's exactly what happened earlier this month. Hedge fund manager and billionaire David Einhorn, who runs the market-beating Greenlight Capital fund, took direct aim at Apple's cash with a federal lawsuit.

What's going on?

The complaint, filed in the Southern District of New York, seeks to block one of Apple's proposals for shareholder approval at this month's annual shareholder meeting. The bit that Einhorn objects to is Apple wants to remove the ability to issue preferred stock without asking shareholders for permission first.
Einhorn would argue preferred stock could be used to return a ton of value to Apple's investors. He even held a press conference this week to explain the finer points of his "iPrefs" idea. Yes, the banker wants to coin a new term for a fairly standard financial instrument, if only to tie the campaign closer to the Apple brand in the court of public opinion.
Apple could return billions of dollars to shareholders in the standard ways: issue a large dividend or buy back a huge number of shares. IBM and Texas Instruments do both of these things to great effect, and the two have even taken on billions in debt to move their shareholder value boosts along. So there's some precedent in the tech sector, and Apple could simply follow their lead.
But Einhorn says neither option would do much for Apple owners. At best, a $90 billion investment in one-time dividends or special buybacks would increase market value by, well, $90 billion. It's like filling your bucket at one end of your waterlogged boat only to dump it on the other side. Hardly worth the effort, right?

Wait! I've got a better idea!

And that's where Einhorn rides in on a white unicorn, wielding a bold new weapon in his fight for shareholder value. What if Apple issued one preferred share for every regular share you own? These stubs would have a $50 face value and pay $2 in annual dividends for a meaty four-percent dividend yield. "What iPref holders should expect is to receive $0.50 a quarter in dividends, every quarter, forever," Einhorn said. The papers should trade for approximately face value on the stock market, assuming that the payout rate never changes. Ever.
This instrument would meet an unmet need for high-quality savings instruments, Einhorn argues. A four-percent yield on a simple, low-cost stock with Apple's financial muscle behind it, well that sounds like a great alternative to stuffing cash under your mattress. Individual investors with a need for high-interest savings would be a primary market for iPrefs, followed by retirement funds, insurance companies, and other vehicles with a focus on long-term stability.
This would supposedly unlock a ton of shareholder value, because Apple's stock would become attractive to entirely new kinds of investors. Income investors could buy the iPrefs while growth and value hounds gravitate toward regular shares. There is no compromise between business investments and dividend grants.
"The reality is that equity investors value companies using a number of metrics that have little to do with the common dividend yield," he said. So why not keep 'em separated? Everybody gets exactly what they're looking for—no more and no less. As such, he expects each iPref to take $20 off the value of regular Apple shares while they add $50 of face value themselves. So it's a net gain of $30 per iPref or an immediate 11 percent boost of total value.
Apple should start small so it doesn't confuse current investors, but could issue several rounds of these spiffy iPrefs over a couple of years. Five iPref distributions would effectively achieve the same thing as doubling the regular dividend to 4.6 percent. In the end, the company could spend less on iPrefs than it would invest in buybacks and dividend increases, but stock owners would see a dramatically greater difference in their portfolios. The preferred shares should raise Apple's total shareholder value by $150 per common share.

Is this for real?

If this sounds like magic and fairy dust to you, you're not alone. Einhorn presented his plan to a room full of seasoned financial professionals and he still had to explain many of the core concepts all over again in the Q&A session. The iPrefs plan may seem blatantly beneficial to Einhorn himself, but comes off as a Jedi mind trick to many observers.
The lawsuit isn't exactly meant to force Apple's hand in this direction. The proposal Einhorn objects to wouldn't make it impossible to issue preferred shares, just a little bit harder because Apple would need shareholder approval first. The current "blank check preferred stock" measure in Apple's bylaws is typically used as a defense against hostile takeovers, and it often goes by the more controversial "poison pill" moniker. For example, Netflix just added a preferred stock poison pill so it could stave off Carl Icahn's unwelcome advances. If Icahn builds a Netflix stake larger than ten percent of the company, a sudden flood of preferred shares would be issued to everyone but him, reducing his investment to a fraction of its former voting power.
Einhorn's proposal has nothing to do with takeover shields. It's kind of hard to find a buyer for something with a half-trillion-dollar price tag after all. Apple claims getting rid of the blank check provision would actually be good for shareholders, because management and directors would have less power to mess with your investments. Several large Apple shareholders would agree, and they plan to vote in favor of the proposal that Einhorn wants stricken down.
New York judge Richard J. Sullivan said it seemed improper to bundle that proposal with two other minor changes to the bylaws. Einhorn himself likes the other changes, which means he'd be voting against his own interests no matter what he does. That was enough to keep Apple's bundle off the table this year, as judge Sullivan ended up ruling in Einhorn's favor.
Einhorn's preferred stock idea may be good for investors, but his lofty value-unlocking targets seem a bit larger than life. The whole lawsuit drama shouldn't make much of an impact on Apple's capital plans one way or the other, but it does bring plenty of sweet spotlight to Einhorn's proposal. When you're doing battle with an Apple-sized behemoth, that's really all a regular old billionaire like Einhorn can ask for.

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