19th February 2013
Usually when a company is subject to shareholder activism, it is because its management are paying themselves too handsomely, or it has bought a bad business for too much money. It is seldom that it has been too prudent with its balance sheet.
Yet, this is exactly what is happening to Apple. It is being targeted by hedge funds keen that it should start spending some of its $137bn cash pile.
The move by hedge fund manager David Einhorn against Apple is not as simple as urging the company’s management to pay a chunky dividend: Apple is currently proposing to change its corporate charter so that it cannot issue preferred stock without putting the issue to shareholders. In this, it has the backing of influential US consultancy ISS and some of the major US pension funds.
Einhorn, who runs the $8.8bn Greenlight Capital fund, is trying to block that move, launching a lawsuit alleging that bundling the vote on the change is against SEC rules. But he has a wider plan: His ultimate plan is for Apple to issue $50bn worth of preferred stock paying a 4% dividend. He believes that this reconciles the competing needs of shareholders who want income and those who want growth. The Financial Time (Ft.com) describes it as a ‘Solomon-esque’ solution: “cut the stock in half to give them both what they want”.
Apple has responded dismissively, calling Einhorn’s move a ‘silly sideshow’. ISS says any benefits “need to be balanced against the drawbacks of creating a second class of shares, including the possibility for the interests of common shareholders to diverge from those of preferred shareholders over time”. It also says that in principle it “supports the elimination of a board’s right to issue “blank check” preferred shares, because of their potential to be misused in a takeover defence”.
The vote is likely to go ahead on Wednesday and the outcome is with the lawyers, but there are wider issues at stake for investors. Apple’s share price has fallen around 10 per cent since the start of this year, underperforming the S&P 500 by almost 20 per cent. Its cash pile is starting to look like a liability. Lothar Mendel, chief investment officer at the Paradigm Group says: “A lot of technology companies are sitting on such big cash piles that they will eventually have to return money to shareholders or be accountable for why not.” Groups, such as Microfocus, have won stock market hearts by returning cash to shareholders and other management teams are taking note.
Technology companies have had good reason to hoard cash: Companies have been concerned about the fiscal cliff and have not wanted to spend cash when they may be vulnerable to short-term problems. Technology companies, who may live or die by their next product, also need to ensure that they have money to spend on research and development.
However, there is an increasing feeling among investors that this has gone too far. Mendel says: “Companies are sitting on cash piles and there is a backlog of missed investments. Companies are finding it difficult to increase their profitability. You can only sweat your assets so hard and then it stops.” Eventually, to grow, they will have to spend.
Apple appeared to acknowledge this in its response to Einhorn’s proposition. Chief executive Tim Cook said that he was actively discussing a series of alternative uses for the group’s cash pile, including returning cash to shareholders, investing in its retail stores and large-scale acquisitions. Walter Price, manager of the RCM Technology trust believes that capex will pick up across the technology sector as the economic environment becomes, if not better, then at least more predictable.
Price believes that technology companies also have the potential to be good income payers if this is how they choose to deploy their cash weighting: they have good growth, good quality of earnings and strong free cash flow. There has been a change in the culture within many technology companies and dividend payouts are no longer seen as an admission that a company is ex-growth.
In this Felix Salmon blog on Reuters, he points out that there are wider economic issues at stake in encouraging many of these companies to spend their cash mountains. He frames it as a moral question – companies need to do it for the good of their economy.
Lots of companies are hoarding cash and it is a problem for the whole economy. The difficulty for Apple is that it is the world’s biggest stock. Its cash pile would make a sizeable dent in the nation’s debt. As such, it is firmly above the parapet, a target for hedge funds and speculators. Investors want to make an example of it. The cash may not be spent in the way that Einhorn envisages, but expect Apple executives to start spending nevertheless.