Carl Icahn’s Apple Tweet and Shareholder Activists

Carl Icahn’s short Tweet about his 9/30/13 dinner meeting with Apple’s CEO Tim Cook seems to have triggered some angry reaction by some commentators (see Tweet). In his Tweet, Icahn stated Apple should consider using its $ 150B+ cash hoard to buy back its undervalued stock. Some commentators are incensed that, although he is a major shareholder, he could call into question the use of Apple’s cash, or worse yet, demand its return to shareholders. I guess they believe that shareholders, like children, should be seen, but not heard.

Earlier this year Apple, prodded by another activist - David Einhorn, agreed to a major debt financed stock repurchase and dividend program (see Dividend). Nevertheless, Apple’s cash continues to grow. Apple, however, appears to be transitioning from a rapidly growing technology firm to a maturing consumer electronics company. This change is difficult for Apple’s senior management and many commentators to accept.

Companies experiencing life cycle changes find it difficult to accept change and cling to the hope they can regain their mojo. After-all, didn’t Steve Jobs accomplish this very feat 15 years ago? Unfortunately, the supply of Steve Jobs’ may be limited.

Activist investors like Icahn and Einhorn are concerned with the value destructive impact of firms failing to adapt. They are aware of Schumpeter’s creative destruction whereby firms are only king for a day (see Creative Destruction). Furthermore, they are especially concerned with Jensen’s free cash flow (see Warning). Jensen highlighted the excess cash flow leads to empire building. Consequently, financial policies like maintaining large cash balances that may have been appropriate for the younger Apple may no longer be appropriate. Evidence indicates that activist shareholders, bringing up inconvenient truths, have a positive impact on maturing firms by forcing them to disgorge cash instead of wasting it on misguided growth.

Companies like Apple should consider aggressive changes in their financial policy including increased dividends and debt financed share repurchases at the right price. Managers may dislike shrinking their kingdom even though such action makes their citizen shareholders richer. They, along with populist commentators, want a return to the past instead of realistically facing the future. They frequently allege the activists are destroying a great franchise. What they miss, however, is the return cash can be invested by investors in new Apples rather than trapped in the old lemons.

The capital markets are not museums to preserve once great companies - well at least for everyone but the French. The capital markets are complex adaptive systems in which firms are born, grow and are replaced. That is the key for a dynamic economy, and the efficient allocation of capital.

We may not like what the activists say or how they say it, but they provide a valuable catalytic function. Sorry for the rant.

J

PS Less than 2 months to Acquisition Finance in Amsterdam.  See the link here.

Schumpeter's Ghost and Jensen's Modern Industrial Revolution

Joe's recent post on Schumpeter inspired me to revisit a modern version of the same points, this time by the father of modern corporate governance, Michael Jensen.  Read what Michael wrote over two decades ago about 'The Modern Industrial Revolution'.  Keep in mind that this was written at a time of rapid change in business as the hostile takeover wave of the 1980's had shaken managerial complacency.  The degree of rapid change two decades ago seems sloth-like in view of the digital revolution that has encompassed the last two decades.  As we have noted, changes in technology provide one of the catalysts for increased merger activity.   But that increase in merger activity can  be associated with positive or negative shareholder wealth changes.   Joe noted the problem of large bureaucratic firms chasing growth through mis-guided acquisitions in an attempt to recapture growth.  Note the parallels in Jensen's article, and how applicable these arguments are today as they were over twenty years ago.

The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems

Abstract:      
Since 1973 technological, political, regulatory, and economic forces have been changing the worldwide economy in a fashion comparable to the changes experienced during the nineteenth century Industrial Revolution. As in the nineteenth century, we are experiencing declining costs, increasing average (but decreasing marginal) productivity of labor, reduced growth rates of labor income, excess capacity, and the requirement for downsizing and exit. The last two decades indicate corporate internal control systems have failed to deal effectively with these changes, especially slow growth and the requirement for exit. The next several decades pose a major challenge for Western firms and political systems as these forces continue to work their way through the worldwide economy.

The complete article can be downloaded here.

All the best,

Ralph

BTW, this starts the second full week of an 'international sabbatical tour' that begins in New Zealand and traverses Australia, Thailand and Singapore before concluding in December in Amsterdam for the Acquisition Finance Course with Joe. See the complete description here.  International corporate governance and merger activities share many common, and many disparate themes across nations.  I'll be noting these perspectives, particularly as they relate to merger activity in Europe.