It was a pleasure meeting you for dinner at the end of September. When we met, my affiliates and I owned 3,875,063 shares of Apple. As of this morning, we owned 4,730,739 shares of Apple, an increase of 22% in position size, reflecting our belief the market continues to dramatically undervalue the company, even when taking into account the recent market appreciation, which in turn makes our proposal unchanged with respect to a $150 Billion buyback. We were pleased to hear at our dinner that you appreciated our input and that you would speak to us again in three weeks to continue the dialogue. In anticipation of doing so soon, we aim to reiterate in this letter the point of view already expressed to you directly with the hope of effectively summarizing it for the company’s board of directors and our fellow shareholders.
From our perspective, Apple is the world’s greatest consumer product innovator and has one of the strongest and most respected brand names in history. We consider Apple to be our most compelling investment. I first informed my followers on Twitter on August 13, 2013 of my “large position.” I also expressed to you my opinion that “a larger buyback should be done now.” At that time, we owned 3,448,663 shares and the stock price was $467. Since then we have purchased an incremental 1,282,076 shares (bringing the total value of my position to $2.5 Billion) and we currently intend to buy more.
We want to be very clear that we could not be more supportive of you, the existing management team, the culture at Apple and the innovative spirit it engenders. The criticism we have as shareholders has nothing to do with your management leadership or operational strategy. Our criticism relates to one thing only: the size and timeframe of Apple’s buyback program. It is obvious to us that it should be much bigger and immediate.
When we met, you agreed with us that the shares are undervalued. In our view, irrational undervaluation as dramatic as this is often a short term anomaly. The timing for a larger buyback is still ripe, but the opportunity will not last forever. While the board’s actions to date ($60 billion share repurchase over three years) may seem like a large buyback, it is simply not large enough given that Apple currently holds $147 billion of cash on its balance sheet, and that it will generate $51 billion of EBIT next year (Wall Street consensus forecast).
The S&P 500 trades at roughly 14x forward earnings. After backing off net cash, Apple trades at just 9x (not factoring into account that the company has a significantly lower cash tax rate than the rate Wall Street analysts use). This discount (cash adjusted) becomes even more compelling given our confidence that Apple will grow earnings per share at a rate well in excess of the S&P 500 for the foreseeable future. With such an enormous valuation gap and such a massive amount of cash on the balance sheet, we find it difficult to imagine why the board would not move more aggressively to buy back stock by immediately announcing a $150 Billion tender offer (financed with debt or a mix of debt and cash on the balance sheet).
While this would certainly be unprecedented because of its size, it is actually appropriate and manageable relative to the size and financial strength of your company. Apple generates more than enough cash flow to service this amount of debt and has $147 billion of cash in the bank. As we proposed at our dinner, if the company decided to borrow the full $150 billion at a 3% interest rate to commence a tender at $525 per share, the result would be an immediate 33% boost to earnings per share, translating into a 33% increase in the value of the shares, which significantly assumes no multiple expansion. Longer term (in three years) if you execute this buyback as proposed, we expect the share price to appreciate to $1,250, assuming the market rewards EBIT growth of 7.5% per year with a more normal market multiple of 11x EBIT.
It is our belief that a company’s board has a responsibility to recognize opportunities to increase shareholder value, which includes allocating capital to execute large and well-timed buybacks. Apple’s Board of Directors does not currently include an individual with a track record as an investment professional. In my opinion, any further delay in executing the buyback we hereby propose will reflect this lack of expertise on the board. My firm’s success and my expertise as an investor would be difficult for anyone to argue. Per my investment thesis, commencing this buyback immediately would ultimately result in further stock appreciation of 140% for the shareholders who choose not to sell into the proposed tender offer. Furthermore, to invalidate any possible criticism that I would not stand by this thesis in terms of its long term benefit to shareholders, I hereby agree to withhold my shares from the proposed $150 Billion tender offer. There is nothing short term about my intentions here.
Chairman, Icahn Enterprises (IEP)
The last two sentences are what catch my eye: “There is nothing short term about my intentions here. Furthermore, to invalidate any possible criticism that I would not stand by this thesis in terms of its long term benefit to shareholders, I hereby agree to withhold my shares from the proposed $150 Billion tender offer.”
It isn’t too clear how withholding shares from a tender offer automatically ties you to the long-term impact of the buyback. In the opening of the letter, Icahn mentioned that his firm owned 4.7 million shares of Apple common stock; that is equal to one-third of the average daily volume in the stock over the past 13 weeks – meaning he could sell the entire position in a few days, with or without the tender, and face no liquidity/price issues in doing so.
Of course, Icahn could’ve made a real pledge that would tie his interests to long term investors. For example, he could have offered up a multi-year commitment to the stock – a period over which he would not trade / sell a single share – if Tim Cook and Apple’s board followed his recommendations in full (or with whatever other conditions he felt would be necessary to make that commitment). That doesn’t guarantee they would listen – but it would certainly “invalidate any possible criticism” that Carl isn’t aligned with the interests of long term shareholders (at that point he would actually be one, assuming he kept his promise); unlike his “no tender” offer, this type of commitment would actually guarantee the outcome that Carl suggests he is interested in.
Icahn could also look to Warren Buffett (BRK.B), who has had continued success as a large shareholder – even at times when his presence wasn’t initially appreciated (see The Washington Post). Tom Murphy’s story about Buffett’s involvement in the Cap Cities/ABC deal (DIS) provides an example:
“One of the interesting things that you’ll get a kick out of – without me asking for it, I would’ve never thought of asking for it – when the deal was finished, as we just concluded it, [Warren] says, ‘Tom, I’m going to own 18% of the company – and I’m putting that 18% of the company in your hands the next eleven years; so you vote the stock.’ He did not vote the stock… he put me absolutely in control of the company… He was that kind of guy – he showed that confidence in me.”
As Murphy goes on to note, the move wasn’t particularly meaningful anyways: Due to regulatory issues at the time, taking over a company with federal licenses from the FCC would’ve been all but impossible (just like gaining anywhere near majority control of Apple would be impossible due to its size), but the action spoke volumes about Buffett’s commitment to the management team and the business for the next 11 years.
That seems like a possible route for Icahn – as he notes early on in his letter, he seems quite confident that Apple is run by great people with a knack for doing the right thing: “We want to be very clear that we could not be more supportive of you, the existing management team, the culture at Apple and the innovative spirit it engenders. The criticism we have as shareholders has nothing to do with your management leadership or operational strategy.”
Maybe he should show Tim Cook and the management team his confidence in their leadership and operational strategy by making a real long-term commitment to the company (even a commitment of three to five years would go a long way). Icahn has an easy way to tie his long-term interest to that of Apple’s owners (rather than the traders who turn the company’s stock every two months or so) – and it would remove any concern about his’s intentions. For some reason, it’s hard to see Icahn sitting by passively for a few years as the management team – the one that he “could not be more supportive of” – was given an opportunity to run the business; if he doesn't get his way on capital allocation, I doubt he'll stick around (or leave quietly).
None of this is a critique of Icahn’s proposal; if I was as confident as he appears that the equity is currently trading at a substantial discount to intrinsic value, I would be calling for a sizable share repurchase as well. I think one of his’s biggest problems is that Tim Cook & Co. are skeptical about his interests. In my view, his letter only created reason to question his intentions even further. He could easily change that if he wanted to, by making a real commitment to be a long-term shareholder; his inability or disinterest in doing so really has to make you wonder.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of my portfolio (currently two). In the eyes of a businessman, I believe this is adequate diversification.