Apple should be like Bloomberg

By Felix Salmon
October 29, 2013

I’m very glad that the WSJ has published today’s debate between Farhad Manjoo and Dennis Berman on the subject of Apple. Manjoo has been writing some very insightful columns about the company, including the one yesterday which explained that Apple has many better options, when it comes to spending its cash, than taking Carl Icahn’s advice and essentially mortgaging the entire pile to conduct a stock buyback.

The Manjoo vs Berman debate displays two important phenomena surrounding nearly all public companies. Firstly, there’s the confusion between a company and a stock; and secondly, there’s the bigger problem with going public in the first place.

Upon going public, every company is doomed to be judged by its share price — and, all too often, it’s doomed for the share price to become more salient, in the public’s mind, than the company itself. Icahn, as a speculative shareholder, has only one interest in this game: he wants the share price to rise, so that he can then sell his shares at a profit. And Berman is, conceptually, on Icahn’s side. He talks about what investors want, and says that if Apple makes a lot of money, “there will be no choice but to give back significant sums to shareholders.” He also likes the idea of Apple racking up vastly more debt than it already has:

Right now, Apple has 30 cents of debt for every dollar it brings in yearly EBITDA. The median figure for the Standard & Poor’s 5000-stock index is $1.90 – or basically six times Apple’s current ratio, according to figures compiled using CapitalIQ. Were Apple to have a median amount, its current debt would move from $17 billion to $108 billion. Is that crazy? No.

In short, Apple’s business model exhibits the rarest traits seen in nature: relatively low capital demands and immense profit generation.

This would be funny, if it weren’t so depressing. Berman concedes that Apple is an extremely rare outlier in the corporate world: it makes a lot of money without having to invest a huge amount up front. Most companies which aren’t Apple, by contrast, have to borrow and invest a huge amount of money before they can start generating earnings. Berman’s bright idea, here, is that if Apple is fortunate enough not to have to go into massive debt to finance its investments, then, er, it should go into massive debt anyway, just because everybody else is doing it.

What good would that huge new debt pile actually serve? Well, it might help increase the share price — or it might not, who knows. (Icahn, for his part, is convinced that the share price will rise either way: he says in his letter to Apple that “the opportunity will not last forever”.) Obviously, it would also burden Apple with billions of dollars of fresh liabilities, in the form of new interest and principal payments. But Berman is unfazed: in his world, liabilities are assets, and assets are liabilities. Seriously: he says, on the liability front, that “the key to keeping Apple sharp will be actually to push more money than comfortable back to shareholders”. And on asset side of the balance sheet, he describes Apple’s cash hoard as “something of a liability”, on the grounds that it is “stranded and unproductive”. (Never mind that even under the Icahn plan, the cash hoard will remain untouched, and be just as stranded and unproductive in future as it is right now.)

This is the mindset of the financial engineer, and while it can make lots of money for corporate raiders, that doesn’t make it a good idea. Berman is a fan of Icahn: “the man doesn’t have stadiums named after himself for no reason,” he writes. Well, yes: the reason is that he spent lots of money to have his name put on those stadiums. He’s a wealthy individual. But Berman seems to think that anything which makes Carl Icahn rich must therefore be the right thing to do.

But here’s the thing: Tim Cook is a caretaker of a company which is designed to be around in perpetuity. Icahn, on the other hand, for all that he claims that “there is nothing short term” about his intentions, still has an exit strategy: he wants to buy low, drive the share price up through shareholder activism, and sell high. Apple should go along with Icahn’s plans only if they increase the long-term value of the company — and it’s pretty obvious that they don’t: Icahn is, at heart, advising Apple to have both large borrowings and a large cash pile at the same time. Which is bonkers.

Manjoo, on the other hand, definitely sees Apple as a company — a company navigating a highly fluid environment, and one where most of its profits come from a single product, the iPhone. Apple needs to stay one step ahead of what consumers want, says Manjoo, and it’s much easier to do that if you’re not saddled with interest payments. Even Manjoo, however, has internalized Silicon Valley’s fetish for endless growth, even when the company in question is already a giant. “What I’m arguing,” writes Manjoo, “is that Apple begin using its cash to act like a different kind of company — that it act like the big-thinking, future-proofing, market-share-buying behemoth it could be… the boldest thing Apple could do with its cash is transform itself into a different kind of company.”

Manjoo’s “different kind of company” is a lower-margin company: one where Apple decides to “give away a lot more free stuff”, and buys market share, or even buys a cellular carrier. This is much less stupid than Berman’s idea. The single most exciting thing about my new iPhone 5s has nothing to do with Apple: instead, it’s T-Mobile’s free international data.

But even Manjoo is working on the assumption that all companies must always want to grow at all times — even if that means becoming “a different kind of company” altogether. Hidden just beneath Manjoo’s writing is a pretty Berman-esque assumption: that the share price should go up rather than down, and that Apple should do everything it can to ensure that outcome. When Manjoo exhorts Apple to “act before trouble hits”, the trouble he has in mind is basically anything which causes the stock price to fall significantly lower than it is already.

So let me put forward an even more radical idea: Apple should just keep on doing exactly what it’s doing. For substantially all of its history, Apple has been a luxury retailer, making beautiful, functional, high-end goods. Its retail stores are in the most expensive neighborhoods, and it never discounts — much like Louis Vuitton. Its products are status symbols. And they can cost eyebrow-raising sums of money: the new Mac Pro, for instance, starts at $3,000 — and that doesn’t even include a screen.

In general, companies are good at doing what they do well, and they’re not good at doing what they don’t do well. That’s one big reason why mergers, and pivots, generally fail. Apple is fantastic at product design, and at maintaining extraordinarily high quality standards on everything it produces. At some points in time, its products touch the public nerve more than they do at other points. No one expects the iPhone’s dominance to last forever: that’s why Apple is trading at about 13 times earnings, while Google’s multiple is more than twice as high. (Don’t even get me started on Amazon.)

Debt makes sense when you need money to invest today, and can repay that money with a substantial future income stream. Apple is in the exact opposite situation: it needs no money to invest today, while its long-term future income stream is quite uncertain. So it makes sense to save up in flush years, like it has been doing. It will continue to create amazing new products; what’s less clear is whether any of those new products will have the ability to become a world-conquering profit monster like the iPhone. The job of the markets is simply to price the shares accordingly; it’s not the job of management to change the deep structure of the company just to make the markets happy.

Steve Jobs always regretted going public. He raised very little money by doing so, and in return he ended up with people like Carl Icahn constantly second-guessing his decisions. Jobs was good at ignoring such gadflies; his successor, Tim Cook, is a little more shareholder-friendly. But shareholders really do nothing for Apple, which hasn’t had a public stock offering in living memory, and which has so much money now that it can pay its employees large amounts of cash to retain talent, instead of having to force them to gamble with restricted stock units.

In other words, Apple should be run a bit like Bloomberg: as a profitable company which pays well, which concentrates first and foremost on making its product as great as possible, and which doesn’t try to be something it’s not, or allow itself to be distracted with financial engineering. Sometimes its stock will go up, and sometimes its stock will go down. But the company, and its core values, will endure.

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Comments
16 comments so far

Fortunately, Cook and the Apple board will pay no attention to analysts and parasites, I mean, speculators, whose only interest is using the stock as a vehicle to get somebody else’s money. Apple’s management knows keeping the rent seekers happy will benefit nobody but them, and may actually harm Apple customers and employees, and even shareholders, in the long run.

Given that, the size of Apple’s cash hoard is still bad for the economy, regardless if much of it is in overseas profits. It’s money that has been extracted from the economy, and since the banks that are holding it are not lending it out to anyone but governments and central banks, it is not being reinvested. Apple, and all other profitable companies, should be given strong incentives to distribute their profits to shareholders (buying shares back does not accomplish that, and there is already a mechanism for doing that – its called the stock market)via dividends.

The big excuse for not paying dividends, or paying paltry ones, is the double tax issue. If the government exempted distributed profits from taxation, and only taxed accumulated profits, publicly owned corporations would have less reason to hoard their profits. Instead of taxing profits and the corporate level and then again at a reduced rate for shareholders, the profits should only be taxed when they are received by individuals, and as ordinary income.

Accumulating profits beyond the needs of a company only benefits management, as it allows them to cover up their mistakes. It hurts shareholders and the economy in general, and should be discouraged. Taxing profits when they get converted into individual income will force management to be held more accountable, and will inject more cash into the economy.

Posted by KenG_CA | Report as abusive

Where I most disagree with this is “Tim Cook is a caretaker of a company which is designed to be around in perpetuity.” Not, perhaps, that that isn’t his mindset, but I think it is one of the flaws of most organizations, large corporations included, that their dynamics end up placing such a high priority on their own self-preservation. Were Apple to become socially valueless, it should go away.

You make a good case for Apple’s having very little debt and a lot of cash, but not as much cash as it has; I’m left thinking they should probably push some of it back toward shareholders, though not in the way or on the scale that the proponents of that are suggesting.

Posted by dWj | Report as abusive

With such a huge pile of cash, why does Apple have ANY debt at all?

Personally I’m disappointed by the way Apple is now going. Felix, you are right, Tim Cook really is very shareholder friendly, and I don’t believe this is in the long term interests of the company either: remember John Sculley? The man who sacked Steve Jobs and followed what the stock market pundits, advisors and analysts wanted and nearly destroyed Apple in the process.

Looking at Apple’s newly released software, Mavericks and the iWork productivity suite clearly shows Apple is hell bent on removing features and functionality that heavyweight hitters need – you should read the huge wave of opposition to the very much more dumbed down new releases on Apple’s own Discussions Forums, hardly a den of anti-Apple antagonists.

Posted by FifthDecade | Report as abusive

“Fortunately, Cook and the Apple board will pay no attention to analysts and parasites, I mean, speculators” -Don’t look now but they’re paying enough attention to have dinner together.

“With such a huge pile of cash, why does Apple have ANY debt at all?” In part because the IRS is holding on to the fantasy that if AAPL builds an Iphone in Taiwan and sells it in Korea that somehow Washington has a right to 35% of the profit AAPL made on that foreign transaction.

“Icahn is, at heart, advising Apple to have both large borrowings and a large cash pile at the same time. Which is bonkers.” Only as bonkers as the tax code you mean.

“No one expects the iPhone’s dominance to last forever: that’s why Apple is trading at about 13 times earnings” If they actually did a 150b buyback they would be around 9 times earnings… unless you agree with Ichan that the share price would move upward.

Icahn might be a heartless raider hell bent on making money with precious little social utility evident in the process… but he’s paid some huge taxes and like most other billionaire “parasites” pledged to give half his treasure to charity.

Posted by y2kurtus | Report as abusive

> to have both large borrowings and a large cash pile at the same time. Which is bonkers.

I am NOT saying I agree with it. But it’s not necessarily bonkers IF you can borrow at a lower interest rate than you can get on your cash holdings. (E.g. one keeps a mortgage even if one has a large savings…) I say that as someone who personally detests debt, and my mortgage is actually my only long term debt. (I use credit cards almost every day, but pay it off every month in full, so I am SAVING money AND it’s more convenient than using cash.)

Posted by mattack | Report as abusive

“With such a huge pile of cash, why does Apple have ANY debt at all?” In part because the IRS is holding on to the fantasy that if AAPL builds an Iphone in Taiwan and sells it in Korea that somehow Washington has a right to 35% of the profit AAPL made on that foreign transaction”

Why, 5thD? So that the US personal income tax rates are raised and you can make up the shortfall?

Earth -> 5thD: Remember what happened in DC in October?

Posted by crocodilechuck | Report as abusive

y2k, Cook is a diplomat. So he’ll have dinner with Icahn. And then he’ll do what he wants. Jobs would just tell him to drop dead.Icahn doesn’t have enough shares to make a difference, and I don’t think Apple mgmt cares that much about the share price anyway.

I don’t have a problem with billionaires in general, just the ones who make their billions by just shuffling papers, especially when they suck the life out of companies, often by loading them up with debt and then walking away with a giant profit. And I’m not convinced they all pay high tax rates.

Icahn, like other parasites, adds no value to his host organism, while extracting all kinds of wealth.

Posted by KenG_CA | Report as abusive

“In part because the IRS is holding on to the fantasy that if AAPL builds an Iphone in Taiwan and sells it in Korea that somehow Washington has a right to 35% of the profit AAPL made on that foreign transaction”

If Apple wanted to incorporate in Taiwan or Korea, then it could do so. Instead, as a company which is heavily based on intellectual property, it presumably reasons that it might be better off taking advantage of the USA and its strong, stable legal code. There are costs associated with doing so. One of which is that the US tax system takes the view (what you call a “fantasy”, although the more conventional term is “liability”) that your contribution to the overall American system which protects and facilitates your profits is measured as a proportion of those profits, calculated on a global basis.

Posted by dsquared | Report as abusive

Apple is progressing as it should. It operates like a Main Street business. It ensures growth by satisfying customers, expanding services and making a profit.

Wall Street has another agenda. It seems to expect a revolutionary product consistently to fuel the share price. What they fail to see is that the next revolution is not about hardware but what one can do with that hardware. The leap to 64 bit processing in mobile, security capabilities via biometrics, proximity interchange through iBeacon and integration with external applications suggests Apple’s ecosystem is focused on just that. Enhanced and expanded capabilities.

The 150B war chest will ensure that they have the resources and advantage to do so. It’s the way Main Street grows.

Posted by 1Brayden | Report as abusive

Agreed dsquared. My only nit-pick with your assessment Felix is that (as someone else mentioned) by hoarding cash Apple management is acting in it’s best interests rather than that of it’s actual owners. A company should only live as long as it provides a benefit to society. By hoarding cash, future Apple management will be able to survive no matter their level of competence. No new product ideas? Poor execution on a product line/market? No matter, we have these billions in the bank that we can use to paper over those failures in some sense. Some level of cushion is understandable, but Apple has gone way past that.

Posted by Harpstein1 | Report as abusive

I’ve never seen Bloomberg, L.P.’s financials, but I think it proves the opposite of Felix’s point. Based on everything that I can gather from publicly available information, it appears that Bloomberg L.P. has distributed a healthy percentage of its profits to its owners over the years.

- Merrill Lynch once owned 30% of Bloomberg, L.P. It sold 10% for $200 million in 1996 and 20% in 2008 for $4.4 billion. In each case “Bloomberg” purchased the interest. I am unclear from press reports if the purchaser was the operating company or a Michael Bloomberg entity separate from the company, but that’s a distinction without much difference. In either case, the ultimate source of the cash was cash flow generated by Bloomberg, L.P., because that would be the source for Mayor Bloomberg to have that amount of cash.

- In 2010, Dealbook reported that Mayor Bloomberg moved $5 billion in assets that had been managed by Quadrangle Group to a different manager. These are financial assets other than his ownership stake in Bloomberg, L.P. This amount is good evidence – along with his homes, lifestyle, and philanthropic activity – that he’s received billions in distributions from the company over the years.

- In 2007, Fortune estimated Bloomberg, L.P.’s pretax operating profits to be $1.5 billion. It had grown rapidly over time and at that time Michael Bloomberg owned 68% of it.

Putting all of these facts together, I don’t see any evidence that Bloomberg L.P. is building billions upon billions of cash inside the company. Instead, the best evidence is that the company is paying out a high percentage of free cash flow to its owners. The company has invested to grow the business, which appears to still leave substantial free cash flow, much of which the company then distributes to its owners. Unless someone who has seen Bloomberg L.P. financials tells me otherwise, that’s what the evidence supports.

In the case of Apple, the company is piling up cash that is not reinvested in the business. Short of an enormous acquisition, there is no plausible path for Apple to use that cash, as Harpstein says.

Posted by realist50 | Report as abusive

I’ll agree that the $150 billion buyback proposed by Icahn is an excessive amount, but the right amount – whether a special dividend or buyback – is well beyond anything Apple is doing today. Apple has $147 billion in cash and equivalents. That amount grew by $26 billion in the past year. (BTW, that increase is after Apple spent $8 billion on capital expenditures and $16 billion on financing activities – dividends and share buybacks, net of money raised from debt issuance.)

Of Manjoo’s ideas, the only one on which Apple could plausibly spend anything like $147 billion is buying a cellular carrier (or multiple carriers). I don’t see how that could work for Apple because of 2 severe channel conflicts. As a carrier, it would have to be in the business of selling and providing service to its competitors’ phones – buying say, AT&T, and making it “Apple only” would make no financial sense. Apple would also become a direct competitor of every other carrier, who are important partners for it. Those other carriers probably wouldn’t stop selling and supporting iPhones and iPads, at least in the short-run, but they will certainly be motivated to favor other phone and tablet providers.

The “cushion” and “investment” arguments are plausible arguments for Apple perhaps maintaining a net cash position of something like $30 to $40 billion. (Remember, the company’s cash increased by $26 billion last year, so each quarter it is generating additional cash that it is not currently investing or using for dividends).

The real issue that Icahn is trying to solve with the idea of selling debt is that so much of Apple’s cash is offshore and therefore subject to incremental U.S. corporate income tax if it comes back.

Posted by realist50 | Report as abusive

Can a corporation use pretax profits to fund a stock buyback?
Otherwise Apple’s chest of cash is beyond the reach of Icahn, et al.

Posted by thispaceforsale | Report as abusive

“Debt makes sense when you need money to invest today”… well the idea is that Apple can leverage debt to buy its own shares at crazy low prices. It’s already done that. That’s not a bad idea at all, but taking it to the extreme Icahn wants involves lots of risk with uncertain rewards.

Also, Apple’s capital is not in a bank collecting dust. It’s invested in government bonds and other low risk investments. There’s an argument for saying Apple should do something that could provide a greater return, such as dramatically expanding retail or building new capacity. Those are not easy things to manage, and Apple has had very slim executive coverage lately (effectively no retail SVP for a couple years! Cook has his hands busy managing the world’s fastest growing tech products in a very competitive market, making about 75% of all the profits in both PCs and mobile).

Investors are valuing Google, Amazon and Apple by very bizarre standards that are not equal. That might work out today, but as soon as the economy tanks, I think I’d rather be the one with tons of capital & the ability to switch gears in building lower end, high quality tech hardware with great software, rather than sitting on an ad bubble and a vastly expensive, money losing hardware subsidiary or commanding a vast, razor-thin retail expansion charity inflated by dreamers who now own virtually worthless paper.

Seems that investors on the verge of a bubble never imagine that they could be on the verge of a bubble. But yeah, keep investing in ad companies that plan to force-feed web users with nonstop commercials, because I’m sure that’s going to work out really well!

I’d rather be in the affordable luxury hardware business, backed with the world’s most adaptable software platform, the one that developers actually write software for.

Posted by DanielEran | Report as abusive

Note that Apple is growing at an almost insane pace for a company so large: R&D expenditures quadrupled in the past 5 years, employment did the same (non-retail employment rose over 26% last fiscal year). R&D + CapEx, which the WSJ article says averaged 3.9 billion since 2002 will be over $15 billion next year. There are a lot of products in the pipeline and labs, bet on it. Maybe Cook will buy Intel, especially now that they’ve decided to start making ARM chips. (Note that they also have a history of somewhat paranoid CEOs: see Andy Grove’s book http://www.amazon.com/Only-Paranoid-Surv ive-Exploit-Challenge/dp/0385483821 )

Posted by MaysonLancaster | Report as abusive

In a slight defense of the new Mac Pro, while its price does represent some level of Apple premium, nobody is selling Xeon-class workstations with dual GPUs for real cheap, either.

But as a long-time Apple customer (going back to an Apple II+ in 1979), I’ve been pretty disappointed in the iOSsification of the Mac that’s been happening over the past few years, and having been moving a lot of my work to Linux.

Posted by Moopheus | Report as abusive
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