All Companies Should Issue Apple’s iPrefs

moneyIn order to increase the sagging Apple (AAPL) stock price, famed hedge fund investor David Einhorn suggested that the company should issue perpetual cumulative preferred shares. Here is the presentation if you have not seen it. 

The basic idea is that Apple should distribute to its shareholders one of more of $50 denominated iPrefs that pay an annual dividend of $2. The shareholders can either sell them on the open market where Einhorn expects them to trade at around $50 or keep them a get 4% yield per year ($2/$50).

The main reason for the iPrefs over other ways to distribute income (dividends, share buybacks, etc..) is that it will significantly increase the value of Apple’s shares. For example, if Apple issued 10 $50 iPrefs for each share, it would have to pay an annual distribution of $20/share ($2*$10) and theoretically, you could sell the shares for $500. $500 is above todays Apple share price of around $430. If you add the earnings that are left over after the distribution ($20+share and the $137 billion in cash), Apple would probably trade around $250-$300 post distribution.

The more iPrefs Apple distributes, the higher their valuation will be. The iPrefs also have other advantages:

  • There is no default or bankruptcy in the event that Apple cannot pay the dividend.
  • Apple can wait to bring over the cash pile they have overseas and not have to worry about the tax implications.

The iPrefs will definitely unlock value. How much value will depend on two factors:

  • The number of iPrefs they issue.
  • The price they trade on the open market. I think Einhorn is being too optimistic. They will most likely trade at a 5% yield or $40/share. 

The reason the iPrefs will unlock value is that there is discrepancy between what stable high quality companies trade for and where long-term bond yields are at. With iPrefs, Apple is just levering up the company in a smart way and distributing the proceeds to shareholders.

If I was an Apple shareholder (which I’m not), I would continue to hold the shares because as the shares go down, there is a greater chance that they will issue iPrefs. I will most likely start buying the shares at around $400, if they ever get there.

Microsoft

If Apple ever does issue iPrefs, the first company I will buy is Microsoft (MSFT). This will most likely be Einhorn’s next target. It has a similar profile as Apple:

  • Tons of cash on the balance sheet.
  • Trades at less than 10 times earnings and generates tons of cash ever year.

Last quarter, Einhorn increased his stake in Microsoft by over 40% to over 10.8+ million. 

Other companies that could follow suit are other tech giants such as:

  • Cisco
  • Oracle
  • Dell (if the takeover falls through)

Eliminate dividends

I would take it one step further and eliminate dividends and issue iPrefs to take advantage of the aforementioned discrepancy. It would be a big boost to the stock market.

Disclosure: I do not own any of the companies mentioned above. 

HypeZero10 Returns 17.1% Last Quarter

For those investors new to HypeZero, we run an automated portfolio of 10 of the best investment ideas from the best hedge funds called HypeZero10.

We take the quarterly holdings of the best hedge funds, and then run our sophisticated algorithm on those holdings to pick the 10 ideas.

This algorithm has returned over 199+% since 2004 exclusive of dividends. A $10,000 investment would be worth almost $30,000 in over 8 years.

For the November 15th to February 15th quarter, HypeZero10 returned 17.1% as compared to 12.9% for the S&P.

Here are the results:

Company Price (Nov 15) Price (Feb 15) Hedge Fund 
Apple Inc. (AAPL) $525.62 $460.16 David Einhorn
Sears Holdings Corporation (SHLD) $58.48+spinoffs $47.33 Edward Lampert
AIG (AIG) $31.24  $38.35 Bruce Berkowitz 
Yahoo! Inc. (YHOO) $17.89  $21.02 Dan Loeb
Procter & Gamble Co. (PG) $66.32  $76.54 Warren Buffett 
AutoNation Inc. (AN) $40.28  $46.03 Edward Lampert 
BankUnited, Inc. (BKU) $22.16  $27.57 Wilbur Ross
News Corp. (NWSA) $23.12  $28.90 Donald Yacktman 
Assured Guaranty Ltd. (AGO)  $12.88  $19.61 Wilbur Ross
Canadian Pacific Railway Limited (CP) $90.38 $118.87 William Ackman
Return  S&P Return   12.9%

Check out new holdings for the February 15th quarter at HypeZero10

Disclosure: I am long AIG

Apple Broken Down

Apple White iPhone

Let me preface this article by saying, I am a fan of Apple (AAPL) products. I own an iPhone, a MacBook Pro, and an iPad Mini. So, I am a bit biased. However, I will be objective as possible when talking about Apple as an investment. 

Apple has been the subject of heated debates from bears and bulls. Let’s first look at the bullish arguments and then the bearish argument. 

Bullish Argument

  • Apple’s valuation is cheap. At around $500/share, it has a market capitalization of around $475 billion. It has a huge cash cushion of around $120 billion. It trades at around 10 times 2013 earnings estimate. This is cheap for a company that has been growing earnings 70% a year over the last 5 years (Source: Yahoo Finance)
  •  The biggest contributor to income, the iPhone, is still the best smartphone in the market.
  • Apple products command premium price and margins.
  • Apple just had a major upgrade cycle, iPhone 5 and iPad Mini just came out.
  • The smartphone revolution is still in its infancy. According to the Business Insider in September, “There are an estimated 6 billion mobile handsets in the world, and only about 1/5th of them are smartphones.”
  • Apple is still not supported by the biggest telecommunications network in China, China Mobile.
  • Apple is working on the next big thing, Apple TV. This could be next catalyst for income and stock price.
  • Once users are in the Apple ecosystem, they tend to buy more products and apps. According to Fortune magazine, Apple is projected to generate $22 billion in App store revenue by 2016.

Bearish Argument

  • Yes, Apple is cheap based on past earnings growth. However, future earnings growth is questionable. It is hard to grow a company earning $40-$50 billion a year much less maintain it. A lot of the cash is overseas and Apple would have to pay taxes to bring it to United States.
  • It is debatable whether iPhone is still the best smartphone. Samsung is catching up or has caught up. The different between iPhone is much smaller than what it used to be a couple of years back.
  • Although, Apple’s premium price and margins have lasted in the pc industry, the smartphone industry is different. It’s a different OS (Windows vs Android) and different manufacturers. Unless, Apple makes much better smartphones, the margins will not last.
  • Apple just had major upgrade cycles, but the changes were not revolutionary. Apple’s products are not matching their hype anymore. The first quarter should be huge, but what about the rest of the year.
  • There are a lot of people without smartphones. However, most of the are not the high income Apple customers. A lot of these customers are in India and China where customers are a lot more cost conscious and will not pay a premium price for Apple products.
  • China Mobile and Apple have been working on a deal for years. Even if the deal goes through, China Mobile has a lot more leverage than other telecommunications networks and the deal will not be as favorable to Apple as with other partners.
  • First, Apple TV has to come out. Once it does, it has to be a success. Even if it is a success and say the product is worth $100 billion. That will only equate to about 20% of Apple’s current worth.
  • A projection of $22 billion generated by the App Store in 2016 is nothing especially when you consider that Apple makes 30% of that revenue. If you factor in taxes, the net income from the App Store comes out to less than $5 billion. This is nothing for company worth $500 billion.

My Take

I believe that people who are predicting Apple to fall below $300/share are foolish. I also believe that people who are predicting Apple to go above $1000/share are foolish.

I see Apple now as a value stock that will trade around the $500 range. To me it does not make sense to buy Apple because its market capitalization is so big. It would take tremendous growth and innovation to move a company worth $500 billion. I have a hard time seeing how Apple can move much higher unless:

  • They maintain their margins and gain market share in the smartphone market.
  • Apple TV is somehow a $100 billion+ product.

Having said that I don’t think there is a huge downside to the stock. I do not see it dropping below $400/share. The $120 billion cash cushion should increase to over $150 billion by the end of fiscal 2013. This should provide downside protection.

Disclosure: I do not own Apple stock.

Shorting Pandora

Pandora LogoPandora (P) is an internet radio service. “The company allows listeners to create up to 100 personalized stations to access unlimited hours of free music and comedy, as well as offers a paid subscription service to listeners.” Most of their revenue comes from advertisements that are run between songs. 

Yesterday, the company announced quarterly results that beat market expectations, but provided lowered fourth quarter guidance. The company blamed soft guidance on advertisers being cautious with spending due to macroeconomic concerns such as the fiscal cliff.

Due to weak guidance, the stock is down around 18% to $7.80 today. 

I have wanted to short Pandora for a long time, but never got around to doing it. But, finally I initiated a small short position today at $7.79. Here are the reasons for the short: 

Profitability

Even with huge subscriber growth, Pandora is having a hard time just breaking even. The reason is that Pandora has to pay royalties for every song a user listens to. So, as advertising revenue increases as more users join Pandora, so does the “content acquisition” cost.

In fact, it gets worse. The royalty rates are going to increase every year under the “Pureplay Settlement” with SoundExchange, which has set predetermined prices every year until 2015. 

Pandora has been lobbying in Washington to lower these rates to boost profitability. However, I don’t think anything will materialize and even if something does, it will be a long time away.

Competition

There is plenty of competition in this space. The biggest ones are Spotify, Apple, and Amazon. Spotify has a very similar service to Pandora except

  • Spotify has integration with Facebook which allows users to share songs with friends.
  • Spotify is free on personal computers. You can listen to any song in their library for free.

There has been a rumbling that Apple may enter the interent radio space. It seems a natural fit for Apple and Amazon as they already provide music content.

Also, there is nothing holding users from using other services beside maybe personalized stations that have been created on Pandora.

Conclusion

I am confident that Pandora will continue to go lower. The only thing that could save it is if it negotiates better rates for content acquisition.

Disclosure: I am short Pandora.

HypeZero10 Beats S&P By 3.2%

For those investors new to HypeZero, we run an automated portfolio of 10 of the best investment ideas from the best hedge funds called HypeZero10.

We take the quarterly holdings of the best hedge funds, and then run our sophisticated algorithm on those holdings to pick the 10 ideas.

This algorithm has returned over 170+% since 2004 exclusive of dividends. A $10,000 investment would be worth $27,000 in over 8 years.

For the August 15th to November 15th quarter, HypeZero10 was flat as compared to -3.2% for the S&P.

Here are the results:

Company Price (Aug 15) Price (Nov 15) Hedge Fund 
Apple Inc. (AAPL) $630.83 $525.62 David Einhorn
Sears Holdings Corporation (SHLD) $56.60 $58.48+spinoffs Edward Lampert
AIG (AIG) $34.03 $31.24  Bruce Berkowitz 
Yahoo! Inc. (YHOO) $14.76 $17.89  Dan Loeb
Procter & Gamble Co. (PG) $66.64  $66.32  Warren Buffett 
AutoNation Inc. (AN) $39.53 $40.28  Edward Lampert 
BankUnited, Inc. (BKU) $25.78  $22.16  Wilbur Ross
News Corp. (NWSA) $23.32 $23.12  Donald Yacktman 
Assured Guaranty Ltd. (AGO)  $13.41 $12.88  Wilbur Ross
Canadian Pacific Railway Limited (CP) $84.38 $90.38 William Ackman
Return  +0.0% S&P Return -3.2%

Check out new holdings for the November 15th quarter at HypeZero10. I will have more details, but AIG is the top pick as a number of hedge funds are bullish on the stock.

Disclosure: I am long AIG