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Activist investor sues Apple in bid to unlock its cash

by FP Staff  Feb 8, 2013 03:30 IST

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NEW YORK/SAN FRANCISCO (Reuters) - Apple Inc.(AAPL.O) on Thursday confronted its first major challenge from an activist shareholder in years as hedge fund manager David Einhorn's Greenlight Capital filed suit against the company and demanded that it dole out a bigger piece of its $137 billion cash pile to investors.

The unusual move comes as the world's largest technology company grapples with a tumbling share price, mounting competition in the smartphone and tablet markets, and concerns about its ability to produce new breakthrough products.

Einhorn, a well-known short-seller, said in an interview with CNBC that Apple had a "depression-era" mentality that led it to hoard cash and invest only in the safest, lowest-yielding securities.

Apple nearly went broke in the 1990s before Steve Jobs returned and engineered a sensational turnaround, with products like the iPhone and iPad that became must-haves for consumers around the world. The company's near-death experience has led to Apple to be exceptionally conservative with its cash.

Apple last March, just months after Jobs' death, responded to a barrage of investor criticism over its large cash hoard by initiating a quarterly cash dividend and a share buyback that would pay out $45 billion over three years. At the time, Apple was sitting on $98 billion in cash.

Einhorn's lawsuit targets a proposal by Apple to eliminate preferred stock from its charter. He urged Apple shareholders to vote against the plan at the company's annual meeting on February 27, and put forward a proposal of his own for the company to issue preferred stock with a perpetual 4 percent dividend.

Apple shares, which had fallen 35 percent from the record high hit in mid-September through Wednesday, were up 1.2 percent at $459.83 in the afternoon.

Einhorn, often cited as one of the most committed Apple bulls, remains long on its shares. But he said the company needs to fix its "cash problem."

"It has sort of a mentality of a depression. In other words, people who have gone through traumas ... and Apple has gone through a couple of traumas in its history, they sometimes feel like they can never have enough cash," Einhorn said on CNBC.

In an interview with Reuters, Einhorn said he'd gone to Apple CEO Tim Cook in recent weeks after the company's chief financial officer, Peter Oppenheimer, brushed off his entreaties in September. Cook, who is rarely known to engage investors in exclusive conversations, was unaware of the earlier conversations with Oppenheimer, according to Einhorn.

"When I discussed this with Tim Cook, and actually, the conversation has been going on for the last couple of weeks, he said that he wasn't familiar with my previous conversations with Peter Oppenheimer and whoever Peter Oppenheimer's advisers were. I was surprised by that," Einhorn told Reuters.

Apple fired back on Thursday afternoon, saying Einhorn's lawsuit over the shareholder proposal was misguided.

"Contrary to Greenlight's statements, adoption of Proposal #2 would not prevent the issuance of preferred stock," it said in a statement.

"Currently, Apple's articles of incorporation provide for the issuance of 'blank check' preferred stock by the Board of Directors without shareholder approval. If Proposal #2 is adopted, our shareholders would have the right to approve the issuance of preferred stock."

SHARES "UTTERLY MISVALUED"

Einhorn's actions go well beyond the increasingly common shareholder calls for Apple to increase its dividend or buy back shares. Einhorn argues that preferred stock - which functions like a bond in that it pays a fixed dividend return over time - is a better route because the company won't have to use cash right away.

Analysts say another benefit is that up to 80 percent of the dividends from preferred stock can be tax-free for corporate investors, and it's not logged as debt on the balance sheet. But the tactic is generally pursued by low-growth companies, where capital gains are less assured.

"The idea is powerful, and when I have a chance to explain it to the shareholders, most will see it as an enormous win-win," Einhorn told Reuters.

Calling Apple shares "utterly misvalued" at current levels in the CNBC interview, Einhorn said the company no longer needs to grow at the near-triple digit rates of the past.

For every $50 billion in preferred stock that Apple gives away to shareholders, it could unlock $32 a share in value for investors, Einhorn said, without explaining his rationale.

"We understand that many of our fellow shareholders share our frustration with Apple's capital allocation policies," Greenlight said in an open letter to investors.

"Apple has $145 per share of cash on its balance sheet. As a shareholder, this is your money."

Einhorn said he suggested to Apple an initial preferred share distribution, in which dividends could be funded on an ongoing basis by a relatively small percentage of the company's operating cash flow.

"Apple rejected the idea outright in September 2012," he said, and then refused to withdraw the proposal to eliminate preferred stock from its charter.

Some investors saw merit to Einhorn's argument.

"You have a great capitalist in David Einhorn who is beginning to get them to think about their capital allocation. It's a great company but their greatest weakness is capital allocation," said Mark Mulholland, portfolio manager of the $417 million Matthew 25 fund, which has some 17 percent of his portfolio in Apple.

DIMINISHING CLOUT

Analysts have expected stockholder pressure to increase as Apple's share price declines and its long-term outlook grows murkier.

The California company had $137.1 billion in cash, short-term and long-term marketable securities such as U.S. Treasuries at the end of last year, with over $94 billion of that parked overseas.

The issue will likely be on top on investors' minds when Cook addresses the Goldman Sachs annual technology conference in San Francisco next week. (WHY DON'T WE CUT THIS GRAPH)

"This is something that we continuously assess, the opportunities to both invest in the business and return cash," Apple's Oppenheimer said on the company's post-results conference call last month. "We do consider increasing these programs, and we'll do what we think is in the best interest of our shareholders."

It remains to be seen if other major Apple investors will get behind Einhorn's initiative.

Mulholland called the preferred stock idea "interesting and unique." He also said he supported Einhorn's opposition to the shareholder proposal and would vote against it, saying, "There's no reason to put something like that in."

On the flip side, the California Public Employees' Retirement System, which owns 2.7 million Apple shares, urged investors earlier this week to vote in favor of the shareholder proposal, calling preferred shares a "blank check."

Money managers have complained that Apple both stockpiles excessive cash and does a poor job putting it to work. The weighted-average interest rate earned on its cash, cash equivalents and marketable securities came to just 1.07 percent in its 2013 fiscal first quarter and 1.02 percent in the 2012 fiscal year.

Some questioned if taking the company to court was the right way to induce action.

"If you own the company you should let management have some say in how they run it. I'm not a fan of using the legal system to address what should be a corporate issue," said John Manley, chief equity strategist at Wells Fargo Advantage funds.

Jeffrey Manns, an associate professor of law at George Washington University, said Einhorn does have legal standing to bring his case, even though it has little precedent. Greenlight's lawsuit takes aim at what it calls the "bundling" of several proposals into a single vote.

Greenlight wants the proposals separated so that a vote can be taken specifically on Apple's move to strike preferred shares from its company charter. Greenlight alleges that Apple is not complying with U.S. Securities and Exchange Commission rules requiring separate votes for distinct and unrelated amendments to the charter.

"This procedural legal strategy is merely a vehicle to raise his profile and promote his agenda about shaping Apple's corporate strategy," Manns said of Einhorn.

HISTORY OF ACTIVISM

Einhorn has a history of activism, usually directed at struggling companies or those grappling with management issues. In 2011, he urged Microsoft Corp (MSFT.O) to get rid of chief executive Steve Ballmer, accusing him of being "stuck in the past." Einhorn slashed his stake in the software giant six months later. Microsoft's stock had then been mired at about the same level in a decade.

Einhorn has enjoyed something of a cult following in the $2 trillion hedge fund industry ever since his bearish call on Lehman Brothers in early 2008. But 2012 was not his best year.

Thanks to losses on Apple and in the gold market, Greenlight Capital posted a modest 8.3 percent gain for the year after losing 2.8 percent in December, a person familiar with the fund's performance said. That lagged the S&P 500 index's 13.4 percent gain, excluding dividends.

(Additional reporting by David Randall, Nate Raymond and Nicola Leske in New York. Writing by Ben Berkowitz and Edwin Chan; Editing by Jonathan Weber, Gerald E. McCormick, Lisa Von Ahn, Jeffrey Benkoe and Leslie Adler)

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