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. 

Bought Vodafone!

Last week, I wrote that Vodafone (VOD) was one of David Einhorn’s top picks. I did some due diligence on the stock, and it seems like a great investment. 

Vodafone provides mobile telecommunications services and has significant market share in:

  • Mature European countries such as England (100% ownership, 26% market share), Spain (100% ownership, 29% market share), Germany (100% ownership, 34% market share), Italy (100% ownership, 36% market share).
  • Less Mature Asian and African countries such as India (64.4% ownership, 29% market share), South African (Vodacom Group, 65% ownership, 58% market share)
  • United States through 45% ownership of Verizon Wireless
  • Many other countries through partnerships and equity investments.

Vodafone has a market capitalization of $135 billion. Its most valuable piece is the 45% stake in Verizon Wireless. The other 55% stake is owned by Verizon.

Verizon has a market capitalization of $125 billion and long term debt of $50 billion. Verizon has two business segments:

  • Verizon Wireless. Verizon Wireless has total revenue of $80 billion. Since Verizon owns 55% of Verizon Wireless, $44 billion of that $80 billion belongs to Verizon. That $44 billion makes up about 1/2 of Verizon’s total revenue. Verizon Wireless also makes up all of Verizon’s operating income.
  • Verizon Wireline (FIOS, etc..). Wireline makes up the other 1/2 ($40 billion) of Verizon’s total revenue. It has pretty much break even operating income. 

Verizon Wireless should make up a majority of Verizon’s market capitalization:

  • Contributes to half of revenue.
  • Makes up less than less than $10 billion of Verizon’s total $50 billion long term debt.
  • Makes up all of its operating income.

Conservatively, it is probably worth around $100 billion.So, Vodafone’s ‘s 45% stake is worth around $80 billion. Einhorn argues it is worth even more.

“Look at it from Verizon’s perspective: Historically, Verizon had a very profitable landline business, and Verizon Wireless owed it billions of dollars. Verizon received Verizon Wireless’s free cash flow as it repaid the debt. For years, Verizon used its control to try to starve VOD by refusing to allow Verizon Wireless to pay dividends. Today, Verizon’s landline business generates no cash and the debt from Verizon Wireless has been repaid. Verizon’s 55% control stake in Verizon Wireless is probably worth more than all of Verizon’s market capitalization, and Verizon has become wholly dependent on dividends from Verizon Wireless to fund its parent company obligations and shareholder dividends”

The rest of Vodafone (excluding Verizon Wireless) in fiscal 2012 had FCF of $6 billion pounds or almost $10 billion. At a valuation of 10 times FCF, the rest of Vodafone is worth $100 billion. According to Einhorn, it should be valued at 12 times earnings, in line with other European Telecoms. 

So, the total value of Vodafone is $180 billion or 33% above its current market capitalization of $135 billion. 

Vodafone seems to be a great investment. There is significant upside and investors are paid to wait with the juicy dividend. 

DIsclosure: I own Vodafone

Insight From Einhorn’s Latest Picks

Greenlight Capital, the hedge fund run by famed investor David Einhorn, just came out with their quarterly letter to share holders. He had interesting comments on some positions:

Apple (AAPL)

Apple is Greenlight’s largest position. Greenlight bought back the Apple shares it had sold in the third quarter. In my last article, I advised readers to stay on the sideline on Apple shares. Obviously, Apple took a big hit today after reporting quarterly results yesterday. Even at $450, I would continue to be cautious and stay on the sideline. If it hits near $400, I will most likely initiate a position, but as I mentioned before this stock does not have huge upside. So, it makes sense to be cautious. 

General Motors (GM)

General Motors is one of Greenlight’s top holdings. He is still bullish on GM even after the recent run up. I agree and am still long GM. It has multiple catalysts:

  • Buy back even more of its shares from the government. They already bought back 11% which should increase eps.
  • Lower pension risks further. It announced last year that Prudential would administer and pay $26 billion of its pension obligations at a cost of $3.5 to $4.5 billion to the company. It can use the excess capital to move more of its pension obligations to Prudential.
  • United States vehicle sales return to a more normalized level as the economy picks up.
  • Europe economy picks up.

Marvell Technology (MRVL)

Marvell used to be one of Greenlight’s top holdings. However, the stock has been one of his worst performers. Earnings and revenue have been down. Recently, a jury awarded Carnegie Mellon University (my alma mater) $1 billion for patent infringement. Einhorn thinks that award will be reduced and the market is also discounting a new product cycle. 

I am avoiding Marvell because I am not confident that the patent infringement award will be reduced and do not understand its products well enough to make an investment.

Vodafone (VOD)

Vodafone is by far the most interesting of Einhorn’s stock picks. According to Einhorn:

  • It pays a 7% dividend.
  • It owns 45% of Verizon Wireless.
  • It trades at 12 times cash earnings excluding the Verizon Wireless ownership.

This definitely seems like a great investment. I will look more into Vodafone this weekend and share my findings.

Here is the letter.

Disclosure: I am long GM.

Einsteins Worth A Look

Einstein Noah Restaurant Group Logo

Einstein Noah Restaurant Group (BAGL) owns, operates, franchises, and licenses bagel specialty restaurants under the names Einstein Bros. Bagels, Noah’s New York Bagels, and Manhattan Bagel brands. It is also a long term holding of famed investor David Einhorn. Greenlight Capital, the firm run by Einhorn, holds over 10 million shares or over 63% of the outstanding shares of BAGL. He has held this position in BAGL for over 5 years. Unlike some of his other investments, BAGL has not been a big success. So, he has been pushing management to increase shareholder value.

In May, management announced that it is exploring strategic alternatives such as a merger or a sale to increase shareholder value. The stock shot up from $14 to over $16+.

In mid October, it provided a peek at third quarter results, and updated investors on the progress of the strategic alternative initiatives  In addition to selling or merging the company, BAGL is thinking about recapitalizing the company and giving a special dividend of $154 million or $9 dividend. Third quarter results were below expectations and investors sent the stock down about 10% from $17.81 to $16.10.

The company also shared the presentation it made to public lenders to secure the recapitalization loan. See the full presentation below.

 

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Recapitalization summary

Here are the details of the recapitalization summary:

  • $265 million in senior secured credit facility.
    • $240 million of that is 1st lien term loan
      • $154 million dividend to shareholders
      • $70 million Refinance existing debt
      • $13 million Transaction expenses
      • $2 million OID
    • $25 million revolving credit facility

The company will be highly leveraged. With a $53 million adjusted EBITDA for 2012, the company will have a pro forma leverage ratio of ~4.5 ($240/$53) . As I mentioned, the dividend will be $9/share.

The transaction was supposed to be completed by November 5th. However, nothing has happened. So, there might be some issues with the recapitalization.

Why worth a look?

The stock has recently dropped from $17.81 in October 16th to $14.37 as of yesterday. It now trades at pre strategic alternatives announcement price. At this price, the company trades at a fair valuation and still has upside if the company is sold or recapitalized.

Valuation

For 2012, the company is on target to earn $.95/share or $16 million. It will have depreciation expense of around $20 million. About $10 million of capitalization expenditures is maintenance capitalization. So, BAGL has about $26 million in FCF. A rough multiple of 10 gives a market capitalization of $260 million. At $14.37, BAGL trades under a market capitalization of $250 million. It is by no means cheap, but it is not expensive here.

It also has other things going for it:

  • David Einhorn holds a majority stake. So, he is going to do everything in his power to increase value.
  • $.50 dividend or ~3.5% yield. 
  • Revenue and earnings have been steadily increasing over last couple of years.
  • Bagels are good and store concept is bright and clean.
  • Growing through not only company store expansion, but also through licensing and franchising.
  • Opportunity for growth. Only 783 restaurants nationwide.

Recapitalization Valuation

 Einstein Noah Restaurant Group Post Recapitalization Earnings

Based on my calculations, there is up to a $5 upside if the company is recapitalized. $9 divided and a $10/share post recapitalization value based on 10 times FCF of $17.5 million.

I want to get in at below $14.5 for an initial small position and add to the position if it goes below $14.

Follow me on Twitter  or like on Facebook for latest trade updates.

Disclosure: I do not own BAGL. 

Buy Xerox


Xerox LogoXerox (XRX)
just reported their third quarter results. Due to a challenging macro environment and government budgetary pressures, operating margins decreased 1 percentage to 8.6% and this had a negative impact on profits. Investors were not impressed and sent the stock down 7.8% to $6.48. However, the lower stock price is an opportunity to buy shares at a very cheap level.

Business

Xerox has three business segments that generate almost $23 billion in yearly revenue:

  • ServicesServices has three offerings: Business Process Outsourcing (“BPO”), Information Technology Outsourcing (“ITO”) and Document Outsourcing (“DO”). Services allow customers to run day-to-day business operations. It contributes over 50% of revenue and is the companies revenue growth driver.
  • Technology. Technology “includes the sale of products and supplies, as well as the associated technical service and financing of those products.” It contributes over 40% of revenue, and the company is focused on maintaing revenue while improving margins.
  • Other.The Other segment “primarily includes revenue from paper sales, wide-format systems, and GIS network integration solutions and electronic presentation systems.” It contributes about 6% of revenue is not profitable.

83% of the companies revenue are recurring (“Annuity”). “Annuity includes revenues from services, maintenance, supplies, rentals and financing.” The other 17% come from one time equipment sales. 

Valuation

Bullish case for Xerox:

  • In a challenging year, the company is on traget for $2 to $2.3 billion operating cash flow and $1.5 to $1.8 billion of free cash flow (FCF). The current market capitalization of the company is $8.3 billion. They are trading at around a price/FCF ratio of 5. If they trade at a ratio of 8, there could be 60% upside to the stock.
  • The company is returning money to shareholders. $1 billion will be used to buy back shares in 2012. $300 million be used for dividends. The company has a 2.5% dividend yield.
  • The company can still improve profitability by cutting costs.
  • 83% of revenues are recurring and company is focused on growing the services division which has more of the recurring revenue.
  • The company is targeting 15% earnings growth over the next coming years.

Risks

  • In a very competitive industry. In services division, competition comes from Accenture (ACN), Aon (AON), Computer Sciences Corporation (CSC), Convergys (CVG), Dell (DELL), Genpact (G), Hewlett-Packard (HPQ), IBM (IBM) and Teletech. In technology division, competition comes from Canon (CAJ), Hewlett-Packard (HPQ), Kodak, Konica Minolta, Lexmark (LXK) and Ricoh (RICOY).
  • Revenue and margins are down this year even though the company spent $200 million on acquisitions. This can be partly blamed on the economy. A lot of the aforementioned competitors like IBM have lower revenue, but unlike Xerox they have  been able to make it up by cutting costs. Xerox is not the strongest of the competitors, but in a stable economy they should be able to at least maintain revenue and margins. 
  • $9 billion debt load. However, this debt load should come down to $8 billion by the year end and over $6 billion is backed by finance receivables. 
  • There is no catalysts for a higher stock price. 

David Einhorn

One investor who agrees is David Einhorn of Greenlight Capital. Here are his comments earlier this year. 

“XRX is a document management provider that entered business process outsourcing when it acquired Affiliated Computer Services (ACS) in February 2010. The combination allows XRX to sell more value-added services to its current customers and apply XRX’s technology to deliver ACS’s services more cheaply. This is our second investment in XRX since the acquisition. The first time, we bought with the stock price around $9.35, and sold with a modest gain over concerns about XRX’s Japanese exposure after the earthquake. That issue appeared fully discounted by the market during the fourth quarter when we re-established a position at $7.61 per share, which is less than 8x estimated 2012 earnings. In the first nine months of 2011, XRX signed a significant amount of new multi-year outsourcing services contracts. XRX has been aggressively cutting costs within the legacy ACS organization. Over the long-term, XRX is expecting over 6% revenue growth and 10-15% adjusted EPS growth. XRX expects to spend $1.0-$1.4 billion on share repurchases in 2012, which should make a good dent in the share count given its current equity capitalization of $11 billion. XRX shares ended the year at $7.96 each.”

Since these comments, Greenlight has added to their posistion. As of June 30th, 2012, they held 26 million shares. Greenlight will report their next quarterly holdings in the middle of November. 

Conclusion

Xerox trades at a cheap price/FCF ratio of 5. They should be able to at least maintain that FCF over the coming years. If so, they should trade at least at a price/FCF level of 8. This would mean a 60% upside in the stock price.

Disclosure: I am long XRX