Thursday morning, David Einhorn's Greenlight Capital issued a press release stating it had filed suit against Apple Inc. (NASDAQ:AAPL) in what appears to be an escalation of its efforts to persuade the company to step up its capital allocation activity. These discussions took place over the last several months, according to Greenlight, but came to light today alongside the legal action.
Greenlight Capital had urged Apple Inc. (NASDAQ:AAPL) to create a new security, a perpetual preferred stock, but Apple reportedly turned down this proposal in September 2012. As such, in advance of the annual shareholders’ meeting on February 27, Greenlight is voicing its opposition to one of Apple’s proposals up for vote (Proposal #2), which the fund alleges would impede the possible future adoption of its preferred stock proposal.
Later this afternoon, Apple issued a statement reiterating its commitment to shareholder value, pledging to “thoroughly evaluate” Greenlight Capital’s proposal, and clarifying its own Proposal #2. If adopted, the company says, Proposal #2 still allows for the adoption of preferred dividends with shareholder approval. In addition, Apple noted that its management and Board of Directors “have been in active discussions about returning additional cash to shareholders.”
This latest example of shareholder activism serves to highlight Apple's significant capabilities for increased capital allocation. Furthermore, Apple’s response today suggests that the company is indeed considering bolder actions. Significant moves on the capital allocation front could greatly improve sentiment and valuation, though many investors continue to focus on the opportunity for a traditional increase in the share buyback authorization and existing dividend.
Greenlight Capital’s proposal and legal action
This morning Greenlight Capital disclosed that its President, David Einhorn, has been urging Apple to create a new security, a perpetual preferred stock that would be distributed at no cost to Apple's existing shareholders. Such preferred stock could trade at par while offering a 4% dividend rate, according to David Einhorn's statements.
A shareholder of Apple since 2010, Greenlight Capital noted its view that Apple is a "phenomenal company" but that the fund is dissatisfied with its capital allocation strategy. According to Greenlight Capital, the dialogue with Apple took place over the past several months, and Apple reportedly rejected the idea in September 2012. The concept of this perpetual preferred stock was first publicly discussed by Greenlight in May 2012.
Apple recently proposed an amendment to its corporate charter ("Proposal #2"), to be voted on at its annual shareholders meeting on February 27, which Mr. Einhorn said would eliminate preferred stock from the charter and impede the possible future adoption of his proposed capital allocation plan. As such, this morning Greenlight Capital also announced that it opposes Apple's Proposal #2 and urged other shareholders to do the same.
Since Proposal #2 includes what Greenlight considers to be three distinct corporate governance proposals, it asked Apple to unbundle them so they could be voted on separately. Upon Einhorn's Apple Inc. (AAPL) Suit Shows the Opportunity: Goldman's refusal, Greenlight Capital sued Apple, arguing that SEC rules require it to unbundle them.
Apple issued a statement later this afternoon, reiterating its commitment to shareholder value, pledging to “thoroughly evaluate” Greenlight Capital’s proposal, and clarifying its own Proposal #2.
“We find ourselves in the fortunate position of continuing to generate large amounts of cash, including $23 billion in cash flow from operations in the last quarter alone,” reads the statement. Apple says that by next week it will have already executed on $10 billion of the $45 billion capital allocation plan announced last year, which includes a quarterly dividend and a share buyback program.
The management team and Board of Directors have continued active discussions about returning additional cash to shareholders, according to the statement, which adds that they will “thoroughly evaluate Greenlight Capital’s current proposal to issue some form of preferred stock”.
Apple Inc. (NASDAQ:AAPL) also clarifies its views behind Proposal #2. According to Apple Inc. (NASDAQ:AAPL), Proposal #2 will prevent the issuance of “blank check” preferred stock by the Board of Directors without shareholder approval. Thus, if adopted, Proposal #2 still allows for the adoption of preferred dividends with shareholder approval. The company says these changes were recommended independently of Greenlight’s proposal, and would not preclude its acceptance.
The statement acknowledges that Proposal #2 includes some additional recommended changes, “to further enhance corporate governance and serve our shareholders’ best interests”, without making any specific reference to Greenlight’s requested unbundling. The statement concludes noting that Proposal #2 has the support of many Apple shareholders.
Goldman Sachs analysts chime in:
While analysts at Goldman Sachs do not take a view on the basis of the legal proceeding, rather they believe that this latest example of shareholder activism serves to highlight Apple's significant capabilities for increased capital allocation.
As of the last quarter, Apple Inc. (NASDAQ:AAPL) held $137.1 billion in cash and long-term investments (or $145 per share), and is trading at a trailing FCF yield of over 10%. Even though just under 70% of this cash is offshore, this still leaves room for substantial incremental capital allocation. Furthermore, it is still possible that Apple Inc. (NASDAQ:AAPL) could also capitalize on its overseas cash position with leverage and other mechanisms.
The analysts believe significant moves on the capital allocation front could greatly improve sentiment and valuation for Apple Inc. (NASDAQ:AAPL), though they continue to focus on the opportunity for a traditional increase in the share buyback authorization and existing dividend.
They view the company's sticky installed base as a baseline for valuation support, and in addition, they expect new products in coming months (including a refreshed iPhone, a new iPad, and a lower cost iPhone) to reinvigorate new user growth. They also believe Apple Inc. (NASDAQ:AAPL) could move towards shorter product cycles, which would minimize the volatility they saw last year and add a key source of stabilization to the story.
Goldman reiterates their buy recommendation and maintains their 12-month target price of $660. Goldman's target price is based on a 14X multiple on their CY2013 EPS estimate of $47.29.