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Why David Einhorn Needed to Sue Apple (Nasdaq: AAPL)

Outspoken fund manager David Einhorn feels so strongly about the need for Apple Inc. (Nasdaq: AAPL) to share more of its cash with its stockholders that he has sued the company.

Shareholders like Einhorn – whose Greenlight Capital fund owns between 1.3 million and 1.5 million shares of AAPL – think the Cupertino, CA-based company should use its monstrous cash pile of more than $137 billion to boost its return.

Einhorn's lawsuit came after his request last year that the tech giant create shares of preferred Apple stock that would exist solely to pay a dividend about twice what the common stock currently pays.

But Apple has included a proposal on its Feb. 27 shareholder ballot that would amend the company's corporate charter to eliminate its ability to create preferred stock. It also has combined that issue with two other unrelated issues in the same proposal.

Einhorn is suing Apple because he says Securities and Exchange Commission (SEC) rules prohibit such bundling, and because he wants to ensure the company will be able to create the type of preferred shares he has proposed.

To further hammer home his point, Einhorn wrote a letter to all Apple shareholders, which was released today, in which he explained his position and urged them to vote against Proposal 2 in the shareholder ballot.

"Proposal 2 is value destructive, impedes the Board's flexibility, and does not merit shareholder support," Einhorn wrote.

Why David Einhorn Is Suing Apple Now

Einhorn points out in his letter that Apple stock has plunged almost 35% from its highs in September.

Apple's soaring stock price was more than enough to keep investors happy, but now few expect AAPL to resume its steep upward trajectory.

With Apple having reached such titanic size that the growth rates of 50% to100% that propelled the stock to $400, then $500, then $600, then $700 are no longer sustainable.

Investors who can't count on steady and rapid growth are going to expect a company to reward them in other ways, such as dividends.

And few companies are as well-equipped to reward shareholders as Apple.

Thanks to the extraordinary success of such products as the iPhone and iPad, the tech giant's cash hoard has ballooned from $15.4 billion in 2007 to $137 billion now. Not only is that the most of any U.S. company, it's growing at the rate of $40 billion a year.

"Apple has $145 per share of cash on its balance sheet. As a shareholder, this is your money," Einhorn wrote in a letter to all Apple shareholders. "Though Apple recently commenced paying a common dividend and initiated a nominal share repurchase program, we believe that there is much more that the Board should do for shareholders."

How the Einhorn Plan Benefits Apple Shareholders

Einhorn's plan sounds familiar, but is unique.

He has proposed the company create $50 billion of preferred shares Like traditional preferred stock, the new AAPL stock would pay a high-yield dividend – about 4% in this case – and have no voting rights.

Unlike other preferred stock, however, the new AAPL shares would not be sold at market, but distributed to current shareholders.

The new Apple stock also would be permanent – investors could buy and sell it among themselves – but would never mature. That removes one of the bond-like qualities typical of most existing preferred stock and ensures Apple would never need to pay it back or refinance it.

In his letter, Einhorn said every $50 billion of preferred stock Apple created and distributed "would unlock about $30 billion, or $32 per share in value. Greenlight believes that Apple has the capacity to ultimately distribute several hundred billion dollars of preferred, which would unlock hundreds of dollars of value per share."

By creating $50 billion of preferred stock as Einhorn describes, Apple would not have to dip into its cash pile as it would with a special dividend, and would pay out just $2 billion a year – easily covered by profits.

In a phone interview on CNBC's "Squawk Box" program, Einhorn said the two types of stock would serve different classes of investors. The common stock will keep its smaller dividend and be more likely to capture gains from future growth, while the preferred stock would appeal to pure income investors.

Einhorn said the idea is a "win-win" for all involved. He specifically cooked up the plan to give Apple a way to supply a larger dividend without sacrificing a large portion of its cash.

Einhorn explained to CNBC that Apple has a "Depression" mentality brought on by several financial traumas in its history, most notably the company's close brush with death in 1997, in the months following the return of CEO Steve Jobs.

"We recognize that the company wants to have a very large cash hoard," Einhorn said. "We came up with what we think is a solution where Apple can maintain its cash and its strategic flexibility and its comfort money and its war chest. At the same time, shareholders can receive the value that is embedded within the balance sheet."

AAPL shares rose nearly 3% Thursday to close at $468.25.

>>Now find out why our analysts believe Apple Is at the iPhone's Mercy.

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  1. Skip | February 10, 2013

    I think Einhorn is extremely short sighted and is so concerned about lining his and his funds pockets he is acting on his own self interest and not taking into consideration what it takes to navigate through the gauntlet in the high tech industry. I am not saying I blame him, he does follow the basic tenant of the "individual acting on his own self interest for maximum utilization." Or said another way, personal interest (the me, me, me of the shareholders today) trumps the need of the company over the long term. But is it really "the shareholders money?"

    They see a little downturn and fail to see the big picture. Competition has risen with the innovation of downstream fast followers, thus margins has eroded and market saturation is being approached. So rather than have the cash available for innovation sparked by research to develop the next upstream disruptive products it must be time to get your money while the getting is good. Not really a good way to run a company, but what does Apple know about navigating through tough times (This is sarcasm in case you didn't get it).

    Maybe Michael Dell has the right idea. Take Apple private where the company can create a war chest for growth, fund research and industry downturns or eroding margins.

    Thus there will be funding to maintain growth as margins erode, increased ability to create innovation to capture future high margin products (because among other things, you don't have to please the me, me, me of the shareholders). The company will be able to sustain itself without having to decimate itself and its research in the future.

    The US and Western European corporations' innovative advantage continues in a downward spiral as we see just the opposite in the land the Back Office and World's Manufacture (India and China). Patent applications from the US and Europe are falling further and further behind. Research centers and staffing for these centers are becoming cost prohibitive luxuries few can afford with this mentality of shareholders.

    So please Mr. Einhorn, go ahead, take care of me, me, me now and see less and less and less tomorrow. Drive the company into an empty shell of its current position in the industry. After all the company does in all reality exist for the benefit of the shareholders. It is your right to maximize now if you so desire and unravel the ability for long term growth and sustainability in the future. It is basic of human nature to look at the short term gains over the long term, well at least it is for public companies.

    Meanwhile, we will continue to follow the business models of Dell, Toys R Us, SAS Institute, Cargill, Bechtel, and Cox. Who knows, if Mr. Einhorn is successful enough in his endeavor, we might even be able to help Apple pull a Michal Dell.

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