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.