Dissecting Greenlight's GO-UP Idea

|
Includes: AAPL, CSCO, DELL, HPQ, INTC, MSFT
by: Brian Harper, CFA

Greenlight Capital's founder and figurehead David Einhorn presented what the firm considers a new idea in corporate finance at last week's IRA Sohn investment conference.

The idea addresses what many value types consider to be an issue pertaining to big tech companies: chronically low valuations. Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC), Cisco (NASDAQ:CSCO), HP (NYSE:HPQ), Dell (NASDAQ:DELL) and even Apple (NASDAQ:AAPL) all trade at low historical P/E multiples, particularly when adjusting for cash:

Big U.S. Tech Valuations
P/E (TTM) P/E (adjusted for net cash)
Microsoft 10.6 8.3
Intel 11.0 9.5
Cisco 13.7 8.5
HP 7.6 9.7

Dell

7.7 3.8
Apple 11.3 8.9
Click to enlarge

The P/E ratios of the group as a whole is down by two-thirds in the past decade, and the group has higher returns on invested capital than the market, yet is much cheaper than the market.

Yet most of these names have been absolute and relative dogs over the past few years. Einhorn is proposing that these companies distribute preferred shares comparable to the company's current market cap to shareholders. The preferred would pay a dividend corresponding to the company's overall credit quality, with Apple and Microsoft hypothetically paying the lowest, at 4%, and General Motors (NYSE:GM) at 6%.

Following the distribution, shareholders could sell this preferred for its theoretical (Greenlight assumes) par value, and value would be unlocked. Dividends would be cumulative but could be deferred under adverse conditions.

Greenlight subtracts the hypothetical preferred dividend from current company earnings to arrive at adjusted earnings. Greenlight then assumes that the common stock trades at the same multiple to adjusted earnings that the stock presently trades to earnings.

At this point we paused. While all of the companies Greenlight listed are highly profitable and could carry the dividend, we are talking about a massive amount of securities which, while technically equity, and while not mandatory, are a fixed obligation. The preferred would consume between 25% of earnings (for GM), to 47% of earnings for Marvell (NASDAQ:MRVL). It's hard to imagine investors would assign the same multiple to the common when the residual to common holders is much lower, and is levered up by the preferred. Earnings would overall become much more volatile, and this higher level of earnings variability typically commands a lower multiple in the market.

Would Greenlight's proposal unlock some value? We think most likely it would unlock a good deal, but with some serious trade offs. Will any of these companies GO-UP? Doubtful. Corporate managements would be reticent about saddling their companies with very high fixed costs.

Disclosure: I am long MSFT, INTC, CSCO, DELL, HPQ.