pocohonta's  Instablog

I listened in to Greenlight Capital's conference call on Feb. 21, 2013 about Apple's (AAPL) capital structure and the proposal by Mr. David Einhorn to unlock shareholder value through the use of "iPrefs". Here's my notes.

Mr. Einhorn begin by praising the company's technological success and innovations, and briefly reflected on Apple's humble beginning where Apple embraced the concept of "rainy day fund". He believes that such conservative approach to cash management resulted in bloated balance sheet and ineffective use of cash. He realizes Apple's priorities as 1) technological innovation, 2) ability to pursue acquisitions, and 3) never be in financial jeopardy.

He pointed out that idle cash decays while earning sub par interest, much like idle inventory which loses value just by sitting on the shelf. He also pointed out that the offshore earnings should remain oversea and not be repatriated, unless there is an tax holiday (similar to the one enacted in 2004). Due to the tax burdens, "No CFO wants to bring back cash this year only to find out there's a tax holiday next year." Clearly, he is adamantly opposed to Apple's current practice of "cash hoarding."

He compared several tech companies and how their cash management practice and shareholder-friendliness affects the PE multiple, share prices, and effectiveness of the methods used to return shareholder cash. He gave positive examples where IBM and Texas Instrument are shareholder-friendly and carries debt, and negative example where Dell with lowest PE and hurt shareholders.

There are four traditional way to unlock value, and one additional way which he is proposing.

1) Large one time dividend. (he used an example where up to $89/share would theoretically be unlocked)

2) One time purchase via self-tender of shares (he used $84B as an example to show how it will redeem 15% of outstanding share, result in 17% higher EPS, which unlocks $75/share or more.

3) Future share buy-back using domestic cash until it runs out, then repatriate.

4) Increase quarterly dividend.

5) Issuance of preferred stock (or "iPref" as he coins it)

The iPref is not a debt, but is a form of equity. In the worse case scenario, it will not result in creditor's claim but may result in the suspension of common stocks' dividend.

The iPref pays out less than 1/4 of the earning so it does not interfere with acquisition or share buy-back.

The iPref lowers the cost of capital and increases financial flexibility.

So, is this "iPref" a form of Financial Engineering? Well, it does not increase the intrinsic value of Apple, but it will minimize the cost of capital, and allows Apple share price to approach its intrinsic value.

Who are the potential buyers of the iPref? Any institutions (i.e.. insurance companies) and individuals seeking higher but safe yields. (he hinted that Greenlight will be a seller of iPref if it ever issued)

So in summary, he likens the iPref as "Apple gets its cake and shareholders gets to eat it too."

Finally, he strongly encouraged shareholders to vote no on proposal 2, and said that by voting "no", it sends a message to the Apple management that it needs to do more to unlock shareholder value by improving its capital structure.

The concept of distributing preferred stock to unlock shareholder value is a concept that Greenlight Capital have been preaching for a while. See "Greenlight Opportunistic User of Preferred" https://www.greenlightcapital.com/default.asp?S=893606

The slide presentation and the recording of the conference call is available at Greenlight Capital's website. www.greenlightcapital.com

Disclosure: I am long AAPL.

The Apple earning conference call can be heard here: 2PM Pacific http://events.apple.com.edgesuite.net/12epjwgpjviociytiy10/event/index.html

Below are the notes I've taken for Apple based on the recent news, articles, and carrier stats. cited. Where I said "NOTE:" it is my opinion.

Revenue (Q4-2012)
company guidance $34B
Street est. 36.27B-36.39B consensus (Q2 Rev was 35B, sale 28.3B)
Most pessimistic estimate is 33.3B revenue
NOTE: If Revenue > 36.4 then it BEATS. If < 36 then it MISSES. If <34 then it MISSES BADLY

Revenue Guidance for Q1-2013
Q1-2013 Street's est.54.72B
NOTE: If company guidance is <54 then neutral to bad. (neutral because they're always conservative)

EPS Q4-2012
Company guidance $7.65 (prior Q3 was $9.42, missed 11.31 est)
Street est. $8.88 to 8.91 consensus mean consensus is $8.84 (8.75 based on Thomson Reuter) Whispernumber.com -> 8.98
It started at an optimistic 10.22 at time of Q3 but it's wrong now
NOTE: If EPS >8.98 then it BEATS. If < 8.75 then it MISSES.

US Carrier stats for all iPhone activations:
T activated 4.7M in Q3
VZ activated 3.1M in Q3 (0.6M iPhone5 in Q3)
S activated 1.5M in Q3
total by 3= 9.3M in Q3
NOTES: Rough calculation not including international sale:
if VZ+T are 24% of all iPhone sale, then AAPL on pace for 33M

All iPhones sales estimate in Q4-2012
27 million iPhone in Q4 consensus
optimistic: 38.0M units but no more than 40M due to supply constraint pessimistic: 24.8M
NOTE: If sales of all iPhone >33M then it beats.

iPhone 5 only in US: >5M as of 9/24 over 1st weekend, 6M-6.5M expected. (Previous 8M-10M estimate is now wrong)
NOTE: If sales of iPhone5 in US > 6.5M then it BEATS

iPhone Guidance for Q1-2013
Street consensus: $49M. Att least 45 million in Dec quarter, but more likely 50M more iPhone5 sale by year end.
NOTE: If company guidance is <45M then it is neutral to bad.
Q3 prelaunch of iPhone5 sales is about 16M, then 11M sold postlaunch, for total of 27M.

All iPads sold in Q4-2012
16.5 million iPad (15-16M seems low, 17-18M seems high) It was 17M in Q3-2012. [comment made by CEO about 100M culmulative iPad sale implies Q4 sales of 16M]

iPad guidance:
Street estimate: 22.3 million iPad in Dec quarter (consensus 22-24M)
recent news Apple ordered 10M unit mini in Q4, production started 10/1

All other hardware:
Mac sold Q3 4.02M in Q4 must sell 5M
iPods sold Q3 6.75M on decline in Q4 must sell 5.6M
iPhones sold Q3 26.03M in Q4 must sell 26.3M
iPads Sold Q3 17.04M (without China) in Q4 must sell 17M

Margin:
Q2=47.37% Q3=42.81%
(iphone 57.9M to 46.38%, about 46% of total sales)

NOTE: do we have margin compression in Q4? and will we have margin expansion in Q1?

Cash equiv. Balance sheet: 117B cash equiv. up 7B in Q3.

Other news:
10/23 USPTO invalidated rubber banding patent
10/22 Samsung terminated LCD supply contract. Already moved memory purchase
9to5 Mac has accurate reporting of rumors
MS Surface 3M-5M pre-ordered for Q4
12/6 judge Koh will rule on ban on 8 Samsung phones
10/11 US Appeal overturn Galaxy Nexus injunction.
10/2 lifted ban on Tab 10.1
9/21 German said GOOG/Samsung don't infringe on multi-touch disabling.
GOOG bought Motorola for patents
iPhone 5 on sale in Australia, Singapore, Japan, Canada, Germany, France UK.
more than 100 countries to sell iPhone5 by year end.
new Apple data centers in HK, N Carolina, Oregon, possibly Nevada.
Galaxy S IV in February
VirnetX refiled ITC complaint on VPN patent USPTO.
Yandex to help with mapping in Russia. Already tapped TomTom
9/14 ITC declare AAPL innocent of infringing 4 Samsung patents
9/14 TSMC replace Samsung as mobile processor foundry partner
9/14 China Unicom to sell iPhone5 in 3 months.
9/13 German declare GOOG infringe Apple's overscroll bounce (rubber banding) patent
9/13 UK: iPhone5's 4GLTE must wait few months.
9/6 apply for patent to sync iphone with car & remap touchscreen keys

16 new stores opened in Q4
U.S. 1 (in California)
U.K. 2
Italy 2
Australia 2
China 1
Germany 1
France 3
Spain 2
Hong Kong 1
Sweden 1

Disclosure: I am long AAPL.

At the time of this writing, Apple (AAPL) is 665 and the weeklies has one day and 2 hours left before expiration. Given the daily range (absolute value of movement) to be around 20 points, and that any high impact news won't be announced until next week (i.e. Apple vs. Samsung verdict), "directional" move of >20 points by close of business Friday is slim.

Based on that outlook, I created a short butterfly trade on AAPL:

AAPL AugWk4 695 Call +10 at 0.16
AAPL AugWk4 685 Call -10 at 0.44
or net credit of 0.28 for the bearish leg
AAPL AugWk4 645 Put -10 at 0.39
AAPL AugWk4 635 Put +10 at 0.19
or net credit of 0.20 for the bullish leg
For a total net credit of 0.48 ($480) but this trade ties up $20,000 of available cash until this weekend.

Assuming that for the rest of this week, the stock stays range-bound within 645 and 685, all four options will expire worthless for maximum profit.

The exit plan is when the stock dips below 650 or pop above 680, I'd begin to watch the trade closely and exit the leg that is at risk, because the potential loss will multiply quickly.

Also, as a side bet, I got a AugWk5 670 Call at 8.5 today. Note that this is week 5 not week 4. (along with my existing long positions) on the possibility that a Samsung verdict by next week will lift the stock further. My exit plan for that call is to either stop-loss at $4 or to close just prior to next Friday.

Wish me luck! Oh, on second thought, I got probability on my side so I don't need luck : )

Disclosure: I am long AAPL.

Additional disclosure: AAPL calls and this AAPL butterfly