Please Yield

12 Feb

The recent lawsuit by prominent hedge fund investor David Einhorn highlights the struggle to prioritize corporate cash in a low rate/no rate world. Mr. Einhorn is imploring Apple to return some of its burgeoning cash stockpile to investors via a preferred dividend. His focus is to return some cash to investors via a significant dividend, but also to boost the value of the preferred shares as yield hungry investors presumably would bid up the shares above what would be a normal earnings multiple. Apple, for its part, has resisted such a proposal as it prefers to keep a comfortable stash of cash to maintain ultimate flexibility. This type of dynamic is currently being played out in the commodities world as well, as companies are being forced by shareholders and boards to shelve or severely cutback their highly aggressive growth plans. Quite frankly, the decision to hold cash at a tech company versus a mining company is quite similar.  Both are interested in growth, but only if that growth is additive.  Market history would suggest that the good times in neither tech nor mining coincided with bright decisions on the capex or acquisition front. However, if you think about it, they face similar fates if they fail to grow with tech companies simply becoming irrelevant, and mining companies risk becoming self liquidating entities as reserves dwindle.

Analysts at Citi recently wrote an excellent note on this point when describing the valuation of Rio Tinto. They stated that Rio Tinto traditionally has traded at a 30% discount to NPV. In essence, they maintain, for every $1 of NPV created by the company, shareholders have been rewarded with 70 cents of value. These analysts suggest that the market is essentially telling Rio Tinto that they do not allocate capital efficiently by not using the correct cost of capital. The thrust of the report therefore is that miners like Rio should use a much higher hurdle rate for projects than they have in the past, and if these rates cannot be met they should return cash to shareholders.

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