Carl Icahn and the Raiders of the Lost Cash

by Mark W. Hibben
8/14/13

Milking the Cash Cow

Carl Icahn has launched a new crusade to relieve Apple of some of its excess, and unused cash. After tweeting that he had taken a "large" position in Apple, Apple's stock price jumped above $500 the following day. Should Apple investors be happy? That depends on your investment time frame. In the short term, Icahn's interest in Apple pumps up the stock price, in the longer term, Icahn's investment history does not bode particularly well for Apple.

Icahn is best remembered for his hostile takeover of TWA in 1985, in which he systematically dismantled the company in order to pay off the loans he used to buy it. Lately, he's been involved in Dell, opposing Michael Dell's attempt to take Dell private and proposing a replacement of Dell's current board and management, including Dell as CEO.

Not that Apple or its investors need to worry that Icahn would launch a hostile takeover of Apple. Icahn's stake in Apple was presumably purchased by his holding company, Icahn Enterprises (IEP), which has a market cap of about $8.8 billion. Apple could easily defend itself simply by buying IEP.

Icahn made clear his objective in a meeting with CEO Tim Cook on the day of his Twitter announcement, in which he pressed Cook for an expanded cash return program. With net cash of about $130 billion (cash less Apple's newly acquired debt), Apple is seen as a cash cow that Icahn would like to milk. For institutional investors with millions of Apple shares, Apple's cash return program is easy money.

For retail investors such as myself, the cash return program is merely a nice-to-have. If Apple divided up the entire $130 billion among its 900 million shares, it would only come to about $144/share before taxes. Retail investors are clearly more motivated to see Apple's share price return to higher valuation, preferably in the $600-700 dollar range.

In order for that to happen, Apple has to be widely perceived as having a bright future. Such a perception as yet doesn't exist. Oracle CEO Larry Ellison recently joined the chorus of Apple doomsayers who assume that Apple without Jobs must fail.

The attention of Icahn only serves to confirm the impression that Apple has no future and that its value as a company is all in its current assets. There is considerable risk of the negative predictions becoming self-fulfilling if Apple accedes to the demands of people like Icahn to deliver up the Lost Cash into their hands.

The greatest fear that Apple's mobile device competitors, Google and Microsoft, must have is that Apple will employ the Lost Cash to compete effectively against them. This potential exists as long as the Cash exists, therefore it is in their competitive interests to see Apple squander the cash in fruitless attempts to bolster its share price through cash return programs. For this reason, Cook should resist the pleas of Carl Icahn.

Cult of Personality

In the past year, a certain cult of personality has developed with regard to technology innovation in general, as proposed by George Colony of Forrester Research. In his April 2012 blog entitled "Apple = Sony" Colony argued that Apple without Jobs was equivalent to Sony without its founder Akio Morita, doomed to drift into mediocrity, a theme that has been repeated ad nauseum since then.

To people like Colony, technology development is something performed by charismatic visionary leaders, such as Jobs, Morita, and Edwin Land of Polaroid, and without these leaders, innovation cannot take place.

As someone who has actually worked in R&D, it was apparent to me that Colony had no clue how tech development is actually done, or what the role of managers of companies such as Apple or Sony really is.

Technology development, whether at Apple, Google, Microsoft, or other companies is largely the product of highly trained scientists and engineers who are passionate about their research fields, and who labor mostly out of the public's view. Such people often move from company to company in their careers, so no company, Apple included, can claim to have a monopoly on innovation.

The role of managment in technology companies is mostly one of filtration, culling through the various research projects that are underway for the few that can be translated into successful products. In this regard, Steve Jobs was uniquely gifted, which allowed him to channel Apple's relatively limited research budget into some phenomenally successful products.

The Competition Innovates

Despite lacking charismatic leaders, Apple's competitors have nevertheless been able to innovate. Microsoft has developed the Xbox One, Windows Phone and Windows 8. Google has developed Android, Chrome, Chromebook Pixel and Google Glass. While innovative, not all of these products may succeed in the marketplace. Innovation doesn't guarantee success, which is why the role of a Steve Jobs can be so important.

Lacking the insight of Steve Jobs doesn't mean that Apple can no longer innovate, but it does mean that it won't be as efficient, which is why Apple's cash pile is so important. Apple's key competitors all spend more for R&D than Apple.

Some have argued that the comparison is unfair because Microsoft and Google are "software companies" while Apple is a "hardware company". Such characterizations are oversimplified. All three companies are mixed hardware/software companies with substantial operating system development efforts as well as hardware development. The proportions of hardware to software may not be exactly the same for each, but the companies are tending to converge in part as a result of emulating Apple.

Fending off the Raiders

Right now, Apple has difficulty just finding ways to spend its cash, but such a state of affairs won't continue indefinitely. If Apple continues to expand R&D, as seems likely with the addition of the new Apple campus, as well as accept lower gross and operating margins because of market share concerns, then Apple will eventually start eating into the cash pile. R&D efforts often take years to bear fruit, so the cash needs to be available for a decade or more.

Given that there are also other important uses for the cash such as capital expenditures and business acquisitions, Apple must protect its cash from raiders. Fortunately there is every indication that it will do so. Apple's statement regarding Icahn was polite but noncommittal:

"We appreciate the interest and investment of all our shareholders. Tim had a very positive conversation with Mr. Icahn today."