In August 2013, Carl Icahn, among the most prominent “activist shareholders” in the United States, announced that he had purchased 27,125,441 shares of the publicly traded stock of Apple Inc.* By the end of January 2014, Icahn had increased his stake in Apple to 52,760,848 shares, equal to 0.9% of the company’s outstanding shares, at a total cost to Icahn of $3.6 billion.
When on August 13, 2013, Icahn announced his first purchase of Apple shares, he said in an interview that it was a “no brainer” because “even without earnings growth, we think [an Apple share] ought to be worth $625 [$89 stock-split adjusted],” on a day that the stock closed at $463 [$66 adjusted]. What made Apple shares a “no brainer” – a term that Icahn would repeat in a letter to Apple shareholders in January 2014 as well as in a few tweets – was that Apple had the cash and borrowing capacity to do massive stock buybacks that could jack up its stock price.
By the end of March 2016, Icahn had completely sold his holdings. On April 28, 2016 – two days after Apple had disclosed its first year-on-year quarterly sales decline in 13 years – Icahn told CNBC that he had unloaded his Apple holdings because he was “worried about China,” where unsteady business conditions meant Apple stock was “not the no-brainer it was” when he had bought it. He said that his 32-month foray into Apple shares had netted him, “within a few bucks,” $2 billion.
How, with ostensibly little mental effort, did Icahn reap a gain of some $2 billion in 32 months? The answer to this question is undoubtedly of interest to activist shareholders who would like to emulate King Icahn. But it should be of even more interest to those legislators, regulators, and informed citizens who would like to put an end to the extreme concentration of income at the top that has come to be a defining characteristic of the U.S. economy.
In actuality, Icahn’s “no brainer” entailed a well thought-out strategy, honed by decades of experience, for buying, holding, and selling Apple shares. The implementation of this strategy depended on four factors: 1) his wealth, 2) his visibility, 3) his hype, and 4) his influence.
1) Icahn’s wealth
Very few Americans have $3.6 billion to put into the stock market, let alone into the shares of one company. According to Forbes real-time rankings, Icahn’s net worth is $17 billion (May 20, 2016). At 80 years of age, he has been playing financial markets for about half a century. By 2011 he had amassed enough wealth that he stopped managing other people’s money to focus on accumulating more on his own account.
Icahn undoubtedly watched as Apple shares fell from a daily-average high of $90 in September 2012 to $57 in June 2013, even as the company’s sales rose to $135.4 billion over the first three-quarters of FY2013 (ending June 29, 2013) from $120.4 billion over the same nine months in 2012. While, during these two periods, Apple’s profits dropped from $33.5 billion to $29.5 billion, on June 29, 2013, the company showed $146.6 billion in cash, cash equivalents, and marketable securities on its books. With little debt on Apple’s balance sheet, Icahn envisioned a massive transformation of these liquid assets into stock buybacks, and in August 2013 he decided to put $1.6 billion of his cash into Apple shares.
2) Icahn’s visibility
The preeminent corporate raider of the 1980s, Icahn remains highly visible among Wall Street traders and institutional investors. He does not win all the time, but, given the ways in which he has become a multibillionaire, he has a track record that other stock-market players find hard to ignore. Besides 37 Apple-related tweets (he now has 283,000 followers), between October 2013 and May 2015 Icahn wrote six open letters dedicated to the proposition that Apple could and should “increase shareholder value” by doing massive stock buybacks. On October 1, 2013, he sent out a tweet: “Had a cordial dinner with Tim last night. We pushed hard for a 150 billion buyback. We decided to continue dialogue in about three weeks.” Icahn’s dinner guest was Apple CEO Tim Cook.
On October 23, Icahn posted on his website an open letter to CEO Cook in which he wrote: “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).” Icahn wanted a tender offer because its announcement would attract lemming-like institutional investors to buy Apple stock in anticipation of the massive buyback, thus pushing up the stock price at which Apple would repurchase shares. Moreover, SEC Rule 10b-18 governs only open-market repurchases, which it does in part by limiting the volume of daily buybacks that can be done without risking manipulation charges, constraining Apple’s daily purchases to a mere $1.4 billion. Icahn wanted buybacks that would be much bigger and faster than that. And just in case anyone assumed that Icahn was out solely for himself, he concluded the open letter by saying: “I hereby agree to withhold my shares from the proposed $150 Billion tender offer. There is nothing short term about my intentions here.”
3) Icahn’s hype
Of course, given a buyback pump, Icahn would then have been looking for a propitious time to dump his Apple shares. He did not mind collecting the dividends that Apple had started paying in 2012, but gains befitting a billionaire would only come with the sale of some or all of his holdings in Apple. When, however, Cook and the board ignored Icahn’s call for the $150 billion tender offer, he was in for a longer haul, whether he liked it or not.
With Apple’s stock price in the $65-$75 range, Icahn picked his times in October 2013 and then again in January 2014 to purchase additional blocks of shares, reaching what would be his maximum Apple shareholding on January 23, 2014. On that date, he wrote a letter to shareholders, urging them to support his non-binding proxy proposal that would have instructed Apple to complete $50 billion in buybacks in FY2014, the amount by which the board had increased Apple’s buyback program (from $10 billion to $60 billion) in April 2013. His request for a $150 billion tender offer having been ignored, Icahn felt that Apple was being a bit slow in doing the price-boosting buybacks.
Then, on January 27, Apple released disappointing results for the first quarter of 2014 (October-December 2013). The launch of the iPhone 5 in September 2012 had driven sales to a record $54.5 billion in 2013Q1. The launch of the iPhone 5c and 5s in September 2013 yielded $57.6 billion in sales in 2014Q1, again a record-breaking sum, but hardly the explosive growth to which Apple shareholders had become accustomed. Moreover, year-over-year first-quarter net income actually fell a tad, from $13.078 billion to $13.072 billion. These results pushed Apple’s stock price down 8% from a close of $74.87 on January 27 to $68.88 on January 28.
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On February 6, CEO Cook did a Wall Street Journal interview in which he revealed that “Apple Inc. has bought $14 billion of its own shares in the two weeks since reporting financial results that disappointed Wall Street,” saying that in doing these buybacks Apple was being “aggressive” and “opportunistic.” That move led ISS, the proxy advisory service, to come out against Icahn’s $50 billion buyback proposal. Given the ISS position, in a letter to shareholders on February 10 Icahn withdrew the proposal, stating that “Tim and the board have exhibited the ‘opportunistic’ and ‘aggressive’ approach to share repurchases that we hoped to instill.” In the event, Apple did $45 billion in buybacks in FY2014, and in April 2014 the board increased the buyback authorization to $90 billion from its previous $60 billion.
Higher earnings can also increase stock prices, and to get significantly higher earnings a company generally needs significantly higher sales. In his letter of February 10, Icahn informed Apple shareholders that “in light of Tim Cook’s confirmed plan to launch new products in new categories this year (in addition to an exciting product roadmap with respect to new products in existing categories), we are extremely excited about Apple’s future.” Even though Apple’s sales and profit growth continued to be modest over the remaining nine months of FY2014, Apple’s stock price rose from $72 in February to $97 in September, surpassing the record stock prices set in September 2012. Helping to push up stock prices were not only Apple’s demonstrated commitment to buybacks and dividends, along with a 7:1 stock split in June 2014, but also, and probably of greater importance, expected sales growth from the long-awaited launches of the iPhone 6 and 6 Plus in September 2014.
About three weeks after the iPhone 6 debut, on October 9, 2014, Icahn posted an open letter to Tim Cook, entitled “Sale: Apple Shares at Half Price.” Even though Apple’s stock price of $98 was at a near-record level, Icahn insisted that it should be $203. He once again called for a tender offer, which in an interview he pegged at as much as $100 billion. In addition, lauding Tim Cook as “the ideal CEO for Apple,” Icahn provided his sales and earnings projections, which would, in his view, justify an immediate doubling of Apple’s stock price. He repeated this exercise in a letter to his Twitter followers on February 11, 2015, and in another open letter to Tim Cook on May 18, 2015. These projections predicted revenue growth of about 25% in FY2015 and 20% each in FY2016 and FY2017. In the February 2015 letter, Icahn said that Apple’s share price should be $216 (it was $122) and, in the May letter, $240 (it was $128).
The problem is that Icahn’s sales and earnings projections for 2016 and 2017 were based on dubious assumptions about the prospective drivers of Apple’s growth. The big new product in Icahn’s “exciting product roadmap” was Apple Watch, launched on April 24, 2015. In his forecasts of October 2014 and February 2015, Icahn projected Apple Watch sales of $9 billion in 2015, rising to over $20 billion in 2016 and $33 billion in 2017. In the May 2015 forecast, with Apple Watch now on the market, he reduced its 2015 sales forecast to $6 billion in 2015, but now saw its sales rising to $22.5 billion in 2016 and $45 billion in 2017. From the perspective of May 2016, it is clear that these sales projections were wild, and self-serving, guesses. Apple refuses to release sales figures on Apple Watch, bundling them into the category “other products,” which includes accessories and the iPod. We can deduce from the published numbers, however, that Apple Watch sales were no more than $2 billion in 2015 and $2.2 billion in the first six months of 2016.
Apple’s mainstay product is, of course, the iPhone. Icahn’s October 2014 forecast had 2015 iPhone sales at $130 billion. In fact, its 2015 sales were $155 billion, including a huge year-over-year first-quarter leap from $32.5 billion to $51.2 billion. Icahn adjusted for this error in his May 2015 forecast, predicting $146 billion in iPhone sales in 2015. Assuming that the iPhone would maintain its premium pricing in competition with other smartphone makers, Icahn forecast iPhone sales of $149 billion in 2016 and $159 billion in 2017. In 2016Q1 iPhone sales were $51.6 billion, a small increase over 2015Q1. But iPhone sales fell sharply, from $40.3 billion in 2015Q2 to $32.9 billion in 2016Q2, accounting for virtually all of the decline in Apple’s year-over-year second-quarter sales.
Clearly, Icahn ignored something in his iPhone sales forecasts, and that something was China. Notwithstanding his “worried about China” excuse for dumping his Apple shares in 2016Q2, Icahn had only two references to China in his letters to Cook and Apple shareholders, and no references to China in his Apple tweets. All three of his sales and earnings forecasts ignored geographic segments. In his January 2014 letter, Icahn opined: “The naysayers question whether Apple will be able to participate in this growth without sacrificing pricing and gross margins, especially with competition from Google, Samsung, Microsoft, Amazon and Chinese manufacturers.” Well, the naysayers were right. In his October 2014 letter, Icahn said: “Now that Apple is offering larger phones with roughly the same size screen as competitors’ offerings, and targeting mainland China at the time of its 4G rollout, we expect Apple to take significant market share.”
Yes, from 2014 to 2015 Apple’s sales in Greater China increased from $31.9 billion to $58.7 billion, accounting for 63% of Apple’s total sales growth. And comparing 2015Q1 with 2016Q1, Greater China sales increased from $16.1 billion to $18.4 billion, representing 175% of Apple’s year-over-year first-quarter sales growth. But comparing 2015Q2 with 2016Q2, Greater China sales declined from $16.8 billion to $12.5 billion, representing 58% of Apple’s year-over-year second-quarter sales drop of $7.5 billion, the company’s first year-over-year quarterly decline in 13 years. In April 2016 Icahn professed to have sold all his Apple shares – his 13F filing of May 16, 2016, shows that he held no Apple stock at the end of March 2016 – because he was “worried about China.” Maybe he should have worried more about China during the 20 months or so that he spent hyping Apple’s stock. But, then, throwing China into the mix might have raised a red flag in the hype.
4) Icahn’s influence
Central to Icahn’s hyping of Apple’s stock was his argument, stated in his February 2015 letter, that Apple’s current P/E ratio was “totally irrational” because “the market is somehow missing a very basic principle of valuation: when a company’s future earnings are expected to a grow at a much faster rate than that of the S&P 500, the market should value that company at a higher P/E multiple.” In keeping with shareholder-value ideology, Icahn’s view is that all of a company’s profits belong to shareholders, and his argument to other shareholders in this open letter is that Apple’s current stock price should reflect Carl Icahn’s expectations of Apple’s future earnings. If the “totally irrational” market cannot recognize his expectations, then the company – in this case Apple – should do massive stock buybacks to make the market price rational.
Of course, having captured all the gains for “expected” earnings, shareholders would then, quite rationally, sell their stock. That is the bill of goods that Icahn, with all his wealth, visibility, and hype, tried to sell to “Tim and the board,” and in his letters and tweets he touted his ready access to the Apple CEO. Icahn’s influence on Cook was not enough to secure him as an ally for a $150 billion tender offer. Nevertheless, his influence on Apple’s resource-allocation decisions is unmistakable. From 2012, when Cook’s Apple started paying dividends, through the second quarter of 2016, Apple did a record-breaking $116.6 billion in buybacks along with declaring $39.1 billion in dividends.
Read Lazonick's critique of stock buybacks
Apple calls these distributions to shareholders its “Capital Return” program. But, as is obvious in our account of Icahn’s involvement in Apple, how can the company return capital to parties who never supplied it with capital? As one of us has shown, the only time Apple Inc. ever raised money from the stock market was in 1980 in its $90 million initial public offering. Haven’t these initial public shareholders long since sold their shares and taken their gains? Even founder Steve Jobs sold all his stock in Apple when he was ousted from the company in 1985.
From 1986 through 1996, in the name of maximizing shareholder value, Apple CEOs and their boards did buybacks and paid dividends to the point where in 1996 and 1997 the company was on the brink of bankruptcy. Jobs returned to Apple in 1997, and over the course of the next 14 years, until his death in 2011, eschewed distributions to shareholders, instead retaining and reinvesting the company’s financial resources to build one of the most successful business enterprises that the world has ever seen.
Where was Icahn when the iPods, iPhones, and iPads were being developed? He was busy extracting value from other already-successful companies, adding to the billions that he then used, by virtue of purchasing outstanding Apple shares, to extract value from Apple. It was because Apple had already become a successful company and because its board had already demonstrated its willingness to “return” capital to shareholders who had never given the company any capital that Carl C. Icahn saw the buying of Apple shares as a “no brainer.”
Icahn made $2 billion buying and selling Apple shares because he bought Apple shares when the stock price was low and sold them when it was higher, even though, as we have shown, he had little if any idea of what was driving the company’s growth. If he had really been smart at buying and selling shares, he would have sold his Apple shares on April 28, 2015, when the company’s stock price peaked at $134.54, for a gain of $3.5 billion instead of the $2 billion he took home, bailing out as soon as Apple’s sales growth stalled. Some part of Icahn’s $2 billion “no brainer” came not from Apple’s growth but from the company’s record-breaking buybacks that reduced its shares outstanding by 16% from 2013Q2 to 2016Q2, in the process jacking up earnings per share and supporting higher stock prices.
That having been said, it may very well have been the case that Apple’s earnings from selling innovative products would be even stronger now if “Tim and the board” had spent less time dealing with the likes of Icahn and more time focusing on the development and marketing of those innovative products. In his October 2013 letter to Cook, the person who takes his living as a value extractor informed the person who is supposed to be making his living as a value creator that “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.” Clearly when Carl Icahn speaks, Tim Cook listens. And we wonder why in the economy more generally so much of the value that millions upon millions of workers create daily keeps ending up in the hands of the billionaire class.
* All stock prices and share counts have been adjusted to reflect Apple’s 7:1 stock split for shareholders of record on June 2, 2014.