Hedge fund manager David Einhorn sues Apple, marks biggest investor challenge in years
Apple Inc 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 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 and Apple gadget fan, said in an interview with CNBC that the company harbored 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 such as the iPhone and iPad that became must-haves for consumers around the world. The company's near-death experience has led Apple to be exceptionally conservative with its cash.
Last March, just months after Jobs' death, Apple 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 filed in U.S. District Court in Manhattan targets a proposal by Apple to eliminate from its charter "blank check" preferred stock. The board now has discretion to issue preferred stock but is asking shareholders at its annual meeting on February 27 to vote on a proposal that would first require shareholder approval.
Einhorn urged Apple shareholders to vote against the plan, and put forward his own proposal for an issuance of preferred stock - which he deems superior to dividends or share buybacks - with a perpetual 4 per cent dividend.
Analysts have expected stockholder pressure to increase as Apple's share price declines and its outlook grows murkier. Stock in the company that once seemingly could do no wrong has fallen 35 per cent since its September record high through Wednesday. It ended Thursday 3 per cent higher at $468.22.
Einhorn, often cited as one of the most committed Apple bulls, remains long on its shares. But the fund manager, whose Greenlight had a sub-par year in large part because of Apple's late-2012 stock swoon, 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.
Some investors, who have long railed against what they saw as Apple's ultra-conservative attitude toward its cash, rallied around the principle of returning cash to shareholders.
In an interview with Reuters, Einhorn said he had 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.
But Apple fired back on Thursday afternoon, saying Einhorn's lawsuit over the shareholder proposal was misguided and that striking the "blank check" provision from its charter would not preclude preferred share issuances in future.
"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."
A source familiar with the discussions Apple was having with Einhorn said that talks with Einhorn as recently as this week had been cordial, that there had been friendly disagreement only on whether common shareholders should be allowed to vote on something as significant as an issuance of preferred stock.
But the source added that Apple, while willing to consider investors' point of view, will eventually decide in the best interest of all shareholders.
Oral arguments between Apple and Einhorn have been set for February 22 in U.S. District Court for the Southern District of New York. Apple has until February 15 to respond to Greenlight's suit, after which Einhorn has until February 18 to reply.
"We saw that the proxy came out and we saw they were planning to get rid of preferred and then, we said, 'Wait a minute, we are not going to be able to bring this up again in a good way if we allow them to do this. So we should contest it now,'" Einhorn said in the interview.
Shares "utterly misvalued"
Einhorn's actions go well beyond increasingly common shareholder calls for Apple to increase its dividend or buy back shares. Einhorn argues preferred stock - which functions like a bond in that it pays a fixed dividend over time - is a better route because the company won't have to use cash right away.
Analysts say another benefit is up to 80 per cent of the dividends from preferred stock can be tax-free for corporate investors and it is 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 in Einhorn's argument.
"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 per cent of his portfolio in Apple.
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 2012, with over $94 billion of that overseas.
"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 whether 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, and opposes "blank check" preferred shares.
Money managers have complained that Apple 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 per cent in its 2013 fiscal first quarter and 1.02 percent in the 2012 fiscal year.
Some questioned whether 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 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 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.
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 per cent gain for the year after losing 2.8 per cent in December, a person familiar with the fund's performance said. That lagged the S&P 500 index's 13.4 per cent gain, excluding dividends.
"You could see Einhorn stirring up other activist investors, to twist them. I would certainly applaud their efforts," said Tim Lesko, portfolio manager at Granite Investment Advisors, which owns Apple stock.
How Einhorn turned from Apple advocate to agitator
Hedge fund star manager David Einhorn was arguably Apple Inc's biggest cheerleader on Wall Street with a stake worth about $600 million and an oft-cited prediction that the company's market value would hit $1 trillion some day.
So it was a shock on Thursday when Einhorn announced that he was suing Apple to get it to deploy its $137.1 billion cash pile more effectively and arrest a 35 per cent drop in its share price from a record high logged last September.
Unknown to Wall Street, Einhorn had for months been imploring Apple's chief financial officer, Peter Oppenheimer, to have the company issue dividend-paying preferred shares to reward investors and juice the stock price.
Einhorn told Reuters he felt blindsided when he received Apple's January 7 annual proxy statement and saw that it contained a proposal that would make it more difficult for the company to issue preferred stock.
"We saw that the proxy came out and we saw they were planning to get rid of preferred and then we said, 'Wait a minute, we are not going to be able to bring this up again in a good way if we allow them to do this. So we should contest it now,'" Einhorn said in a phone interview.
Einhorn's $8 billion Greenlight Capital Inc on Thursday sued Apple in U.S. District Court in New York, asserting that its Proxy Proposal 2 would "restrict the board's ability to unlock the value on Apple's balance sheet.
The 44-year-old hedge fund manager, who made his name and fortune by predicting the collapse of Lehman Brothers, is also urging Apple shareholders to vote against the proxy proposal at the company's annual meeting on February 27.
Apple said in a statement that it will evaluate Greenlight's recommendation and denied that its proxy proposal was aimed at preventing the issuance of preferred stock. If Proxy Proposal 2 is adopted, Apple said it could still issue preferred stock as long as it obtained approval from shareholders.
But the extra hurdle, from Einhorn's point of view, was unacceptable and so he took the matter to Apple CEO Tim Cook.
The way Einhorn tells it, Cook was more receptive than his CFO and the two sides are still talking. But Einhorn decided to file suit anyway because of the approaching annual meeting.
"The lawsuit is just to get the proxy sorted out," he said.
Long on apple
Einhorn began investing in Apple in 2010 and holds 1.3 million shares worth about $600 million at current values.
He emerged as a prominent advocate for the stock after it began to fall last year following some disappointing quarterly results, stiffer competition in the smartphone market, and product snafus that fueled fears Apple had lost its innovative edge following the death of co-founder Steve Jobs.
Einhorn said in a letter to investors last month that Greenlight had taken advantage of the drop in Apple's shares to buy more stock in the fourth quarter. That was one reason the fund posted a negative return of 4.9 per cent in the quarter.
Since May last year, Einhorn has been urging the company to unlock several hundred billion dollars of shareholder value by distributing preferred stock, which he favored over a share buyback because it did not deplete cash immediately.
In private conversations with Oppenheimer, Einhorn said Apple could initially distribute $50 billion of perpetual preferred stock with a 4 per cent annual cash dividend paid quarterly at preferential tax rates.
But, according to Einhorn, Oppenheimer and his advisers calculated the dividend to be 8 per cent, which they deemed too high.
"We said, that's crazy. That's crazy. We think 4 per cent. If we're wrong, maybe it's 4.5 per cent or 4-1/4 per cent - it is not 8 per cent. So, we kind of agreed to disagree. We kind of sat on it for a few months," Einhorn said.
When he eventually took the matter to Cook, Einhorn said he felt that the CEO did not know all the details of Einhorn's discussions with Oppenheimer.
"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.
"I think we got the brush-off the first time," Einhorn said about Oppenheimer and his advisers. "I don't know what the communication was" between Oppenheimer and Cook.
Apple declined to comment on the specifics of the discussions with Einhorn.
A source familiar with the matter characterized the interaction with the hedge fund manager as "cordial," saying that there had been "friendly disagreement" only on whether common shareholders should be allowed to vote on something as significant as an issuance of preferred stock.
Einhorn said in a television interview that despite their differences, he felt Cook was doing an excellent job as CEO, but he described Apple's management as having a "Depression-era" mentality that led it to hoard cash and invest only in the safest, lowest-yielding securities.
"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.
Cook and Oppenheimer both joined Apple during the turbulent late 1990s when the tech company was struggling to stay afloat and before Steve Jobs engineered a sensational turnaround with products like the iPhone and iPad that became must-haves for consumers around the world.
Oppenheimer later earned a reputation on Wall Street for extreme conservatism in cash management. The company likes to remain liquid by investing in safe but low-yielding U.S. Treasury and agency debt, shies away from big acquisitions, and repeatedly preaches a "capital preservation" mantra to investors.
Under Cook in 2011, Apple gradually loosened the reins, announcing its first multi-year dividend and share repurchase programs.
Einhorn and Apple will have another bout when they air their arguments on February 22 in court. Before then, the outspoken fund manager will be lobbying other shareholders.
Analysts say one benefit of preferred stock is that up to 80 per cent of the dividends can be tax-free for corporate investors, although preferred shares tend to be less liquid than ordinary shares or bonds.
"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 said.