David Einhorn suing Apple (AAPL) over how the company's plans to eliminate the possibility of preferred shares was the first shot in a war between management and shareholders over cash on the balance sheet.
Corporations started hoarding cash in earnest after the financial crash of 2008. There is more than $3.5 trillion on American balance sheets at this point, but dividend yields at 2.1% in 2012 are historically about average. Corporations argue that much of the cash is held overseas or needed as insurance against the next downturn. Shareholders argue that they are the real owners of the cash and as such deserve a say in how the money gets used.
Jon Najarian, co-founder of OptionMonster.com says it's simply a matter of who can more efficiently put the money to use. "They haven't found ways to deploy and earn better income on (the cash); that's why you give it back to shareholders," he says.
Najarian touches on the heart of the matter. Efficient market investors argue that cash is already "priced in" to share prices. Under this theory, financial engineering like that proposed by Einhorn is akin to thinking Apple would be bigger or larger, depending on how it's sliced.
What's actually priced into stocks is the amount of cash on balance sheets as a function of how that money is used. In growth industries with massive capex needs, cash gives a company the flexibility to exploit opportunity. In slower growth environments cash being held at 2 or 3% with a dividend to match doesn't offer any premium from the market at all.
Einhorn's plan shows but one way for companies to get around the potentially disastrous tax implications of a straight dividend. As Najarian observes, the distribution of preferred stock would give existing shareholders a choice on payout without having to pay extra cash on the initial transaction.
Einhorn's suit is about Apple but the real issue is the need to rethink the standard "buyback and dividend" model of returning cash to shareholders. Buybacks create no organic growth and seem to underperform the broader market. Dividend yields aren't high enough to create a real source of income for risk adverse investors.
The model is broken. It's time for Corporate America either use their cash or figure out a way to give back to the owners.
- Investment & Company Information