Apple (AAPL) is under fire from dissident shareholders for hoarding too much cash. The company is being sued by Greenlight Hedge Fund manager David Einhorn, who is attempting to get Apple to pay out most of its $137 billion in cash reserves to shareholders. Last week, Einhorn won a procedural injunction against Apple, and the issue is likely to come to a head at Wednesday’s shareholder meeting.
Apple is not the only company sitting on excess cash. Large corporations today are hoarding more cash than ever. S&P 500 companies today have cash and liquid investments on their balance sheets worth a record $1.23 trillion. That is up more than 50 percent from just four years ago.
Large cash balances reduce shareholder value because they create reduced returns on capital. In his suit against Apple, Einhorn contends that getting this excess cash off Apple’s balance sheet and back to shareholders would increase the value of the company by $50 per share or more.
Excess cash also has the potential to be misspent on bad acquisitions. Remember eBay (EBAY)’s $2.8 billion Skype deal, Microsoft (MSFT)’s $6.3 billion blunder with aQuantive, and Quaker Oats’s $1.4 billion Snapple write-off?
Excess cash creates pressure for corporate managers to put the cash to work. Increasing dividends or share buybacks are viewed by many executives—particularly those in the tech sector—as a slow-growth strategy, reserved for mature industries.
But the presence of excess cash is a distraction that can cause companies like Apple to veer off track by pursuing wrongheaded acquisition strategies.
Hewlett-Packard (HPQ) is a great example of this. During the 1980s and 1990s, HP was a leader in innovation, and its stock price increased thirtyfold from 1980 to 2000. In the late 1990s, as its balance sheet improved, the company shifted course and began a more aggressive M&A strategy, pursuing large targets such as Compaq, 3COM, Palm, EDS, Autonomy, and others. Many of these deals failed, and the company has declined in value.
Apple’s success over the past decade was driven by a strong innovation program that gave us the iPod, iPhone, and iPad. Organic growth creates significant shareholder value. Acquisitions create little or no value, because companies pay full price for those assets, and many of them fail. Studies by McKinsey, KPMG, and others have consistently shown that only 20 percent to 40 percent of all acquisitions improve shareholder value, with the rest losing money.
In many cases, acquisitions distract companies from pursuing innovation. For most of them, their executives’ time and focus is their single most limited resource. Acquisitions are a huge drain on management time, often causing organic growth programs to be sacrificed.
Quaker Oats’s 1994 acquisition of Snapple not only was a bad move from a financial standpoint but also sapped the energy of the company’s management team as they put all their effort into trying to fix the failed deal. Not only did Snapple fail, but Quaker’s established businesses also began suffering. Eventually, Snapple was abandoned, management was fired, and Quaker was sold off to PepsiCo (PEP).
Most of today’s great companies did not become great because they had hoards of cash. In fact, most were cash-strapped. Great innovation requires very little cash. When Steve Jobs took over Apple in 1997, the company was close to bankruptcy. His lean, “make it happen” attitude helped fuel Apple’s innovation success.
If Apple wants to regain its mojo, it needs to start by getting rid of most of its cash. Then, instead of worrying how to spend its money, it can focus on getting back to its innovation fundamentals.