I used to work on sort of a cats-and-dogs capital markets desk, which occasionally meant that spivvy companies without great access to the equity and bond markets, or industry bankers who were a bit too clever for their own good, came to me and asked "hey, what if we issued preferred stock?"1 I cannot recall that ever working out well. "Preferred stock" is a thing that exists in corporate finance textbooks, and occasionally solves for quirky corporate finance equations ("can we structure this investment as debt only it isn't debt ..."), but its practical uses tend to be limited to:
- private companies, private investments in public companies, joint ventures, VC investments, and other non-publicly-traded things;
- convertible preferred stock, which is not really the same thing at all;
- convertible preferred's weird Warren-Buffett-and-TARP cousin, "preferred stock with warrants"; and
- a couple of sectors that are really into leverage, capital-structure engineering, and retail financing - meaning mostly banks, insurance companies and REITs.
So David Einhorn's too-clever-for-his-own-good "iPrefs" deck brought back fond memories: why not convince a tech company that the next level of financial-engineering innovation is to issue preferred stock? And, since the phrase "preferred stock" does still kind of conjure up turn-of-the-last-century financial markets and/or cheesy cologne, why not rebrand it as "iPrefs"? There is something ... something very investment-banker-y about taking an absolutely standard financial product, giving it a different name, and calling it an innovation. Of course I love it.
The only thing I love more than the name is the ambition. Einhorn wants Apple to issue two hundred thirty-six billion dollars of iPrefs, or five $50-par, 4%-coupon iPref shares per common share. That's more than half of Apple's market cap, but Apple's market cap is the wrong denominator. If Apple took Einhorn's advice and issued $236 billion of listed preferred, it would be issuing more than the entire market cap of all the publicly traded preferred stock in America, combined.2
That is worth keeping in mind while reading his deck. The deck has a funny spot-the-paradox air to it; basically Einhorn goes through a bunch of (similarly tax efficient) ways to divvy up Apple's present cash pile and future cash flows, and ranks them by how much "value" they "create." There are a lot of very smart people who believe that you cannot slice a pie in such a way that you create more pie; most of those people don't work for investment banks, or if they do they keep their mouths shut.3
But I digress. The point is that Einhorn presumes that the market is irrational in how it values Apple, and that iPrefs could reverse that irrationality. (Or, precisely equivalently, that the market is now rational in how it values Apple, and that iPrefs could drive it to an irrational frenzy of overvaluation. Either way is good.) As a former slicer of instruments, I have an instinctive sympathy to that view, and have lazily endorsed it before; I will lazily stand by that now.
But two hundred thirty-six billion dollars! Einhorn lays out a plausible case for Apple pref trading at 4% - basically IBM and MSFT 30-years trade at about 3.9%, and for taxable investors iPref's 4% qualified dividends would be worth as much as a 5.3% taxable interest,4 making them pretty rich versus other yieldy long-duration tech industry fixed-income instruments. If you accept that valuation, and you further accept that Apple's stock would continue to trade at a constant P/E, then this slicing would create something like $150 per share of value, or $142bn total of free money.
If the iPref trades like preferred stocks that currently exist in the world, despite dwarfing all of them in size. Einhorn talks a good game about how insurance companies, individual savers, and lots of other people are looking, in this historically low-rate environment, to lock up their money in perpetuity at a 4% yield, which I guess sounds sort of nuts when you say it like that but is nonetheless inarguably true. So perhaps Apple could in fact be such an innovator in the preferred stock - sorry, iPref! - market that it could basically create that market out of nothing. I mean, whatever, it did it with tablet computers, fine. Still it's a bit of a gamble.5
Greenlight's iPrefs presentation [via BI] [update : and EDGAR]
Live Blogging David Einhorn’s Apple Conference Call [Deal Journal]
Dealpolitik: Why Apple Should Fold Its Cards for Now on Proxy Issue [Deal Journal]
Earlier: David Einhorn Wants Apple Shareholders To Vote On Voting On Issuing Preferred Stock
1.Another form of this dialogue was:
Banker: Hey Matt, who does preferred stock capital markets for [industry]?
Me: [Jane] in investment-grade does, though she doesn't do much of it.
Banker: Oh yeah but I'm actually calling about a $200-million equity-market-cap CCC+ rated company.
Me: Hahaha you can't do that.
Banker: Well what if we ...
Me: Can I interest you in a convertible preferred?
Banker: No no they don't want to issue equity, they think they're undervalued.
Me: Good luck to you.
Typing this just now was strangely cathartic.
2.You can get a rough sense of how big the preferred stock market in America is from the S&P U.S. Preferred Stock Index, which purports to contain every preferred stock listed on a U.S. exchange with at least $100mm of issue size and at least 250,000 shares of monthly volume. (Call it $300,000 a day assuming $25 par: not a huge bar.) The total size of that market, per S&P, is $152 billion.
3.A lot of them work as academics, actually.
4.Or something. Top tax bracket for ordinary income is 39.6%, top tax bracket for qualified dividends is 20% for 2013 (it was 15% last year). 80% of 4% is 3.2%; 60.4% of 5.298%.
5.Oh also there's a vote and a proxy lawsuit and stuff. We talked about the procedural stuff before; I will refer you to Ronald Barusch for a bringdown. I endorse his take: there is nothing urgent about Apple's ballot proposals that requires them to be voted on this year, so they should withdraw them and try again, with separate votes on each item, next year.