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March 09, 2007
Various Responses To The “Apple Capital” Idea
Last weeks' column “What To Do With Apple’s Cash” – a somewhat revised version of which appears on page 80 of this week’s magazine -- has prompted many responses, some more thoughtful than others.
A few of you wrote in curious about the specifics concerning the line at the end about how Apple was so cash-strapped in the mid-1990s that it was actually in danger of closing its doors within two months. Someone even accused me of making that up. Unaccustomed as I am to accusations of fabulism, I thought I’d explain it here, after the jump.
Before writing the column I talked with a source who’s intimately familiar with Apple’s financial history, and who has about as encyclopedic a knowledge of its history – including the lesser known bits – who mentioned this almost as an aside as we were wrapping up our chat. Two months from closing its doors? Could it really have been that bad? I was curious and turned to the SEC filings from 1995, which was the year mentioned, which would have been late in the Michael Spindler era.
I dug through Apple’s 1995 10K filing, which you can find here. I found this statement under the heading Liquidity and Capital Resources:
“The Company's financial position with respect to cash, cash equivalents, and short-term investments, net of short-term borrowings, decreased to $491 million at September 29, 1995, from $966 million at September 30, 1994.”
This was at a time when it cost about $183 million a month to run Apple (Add SG&A costs to R&D, and divide by 12). That works out to about two months’ worth of cash give or take two to three weeks.
Would the doors have actually slammed shut upon cash hitting zero? Probably not. Companies have a way putting themselves on life support in extreme circumstances in order to buy time. In early 1996 Apple froze R&D spending to save cash, then its senior debt rating was slashed to junk bond status. Then later that year, after Gil Amelio has arrived as CEO, Apple issued $575 million in corporate debt. Either way, during these years the risk that Apple would fail as a going concern was very real. Steve Jobs even said as much to Time Magazine in 1997. Either way, I stand by the statement, because I think it accurately reflects the financial picture of Apple at the time.
However, the smartest response to the column by far was that of Roger Ehrenberg who wrote about the implications of “Apple Capital” at length for his blog Information Arbitrage which was re-published by Seeking Alpha. Roger’s a pretty smart guy on matters of corporate finance and investing, and he argues a more careful and conservative view.
Before considering a dive into the VC world, he says Apple should consider four questions:
What is the right amount of cash Apple should keep on-hand to cushion variability in free cash flow?
What is the process for benchmarking internal vs. external investment opportunities? Are there suitable analytical frameworks in place for making these assessments?
What is the current dollar value of projects - be they internal or external - that warrant investment, given the Company's return-on-investment objectives?
In the event that additional cash exists beyond that required to fund 1 and 3 above, is this excess likely to be a durable phenomenon (e.g., indicating that a change in dividend policy might be appropriate) or a transient event (e.g., meaning an opportunistic stock buyback might be a better fit)?
It’s important to determine how much cash you’ll need in the event of a fiscal crisis. Let’s say, hypothetically, that the iPhone turns out to be a total bomb, and that there some kind of delay with Leopard. That’s going to skew financial projections for the 2007 fiscal year, and require some fast footwork that will eat into some of that cash horde. It’s a fair observation, and I’m no expert at judging Apple’s relative risks versus that of other companies, but cash is probably the best hedge against the unexpected. With experience of cash-poor years like 1995 still lingering in its corporate history, Apple’s management certainly has every reason to be mindful of the old Boy Scout motto “Be prepared.”
Still he agrees that $12 billion seems more than necessary to truly “be prepared.” So then what? Dividends and buybacks? Buybacks are popular these days. Dividends less so, but I’ve got no problem with either one. Acquisitions? We both agree that big ones tend not to work out, while Apple has a history of making carefully-targeted small acquisitions that usually pay off handsomely.
All good options. But setting up an Apple-owned venture capital firm? No guarantees of success, Roger says. Going the VC route raises its own issues of competing cultures within a company, and I think he’s correct in pointing out the pitfalls, which I admit I hadn’t fully appreciated. The trick I think would be to let the VC arm run itself as independently as possible, and probably outside the immediate vicinity of Cupertino HQ. Culture he says, is King, and indeed it is. But I don’t think this is an unsurmountable obstacle to building a successful Apple-owned VC fund.
Venture capital isn’t something you do for fun (although a close friend who is a venture capitalist certainly appears like he’s having fun every time I see him). It takes a great deal of discipline, patience and close attention to strategic goals. Roger points out, correctly I think, that if such a fund were to contribute a lot to the bottom line in one fiscal period, but lose money in the next, it would test the patience both of senior management and investors.
Look at Intel Capital, which last year added $200 million and change to Intel’s bottom line, after a loss of $40 million and change the year before that. You have to prepare the shareholders and management for the ride, and be prepared to stay the course over the long term, and that’s precisely what Intel does, taking the good bets with the bad.
Overall, Roger raises some terrific and important points about risks Apple would face if it were to head down this path. But overall, I don’t think any of them are so complicated as to be dealbreakers. Apple would have to do it right, but I wouldn't expect anything less. And who knows? The results might just surprise all concerned.
I have no clue what Apple’s plans for its cash are. But I do know the questions on this topic are going to get louder as the pile grows. If Apple continues on its current pace, it's holdings will be in the neighborhood of $13 to $15 billion before the end of the calendar year and within range of $20 billion by the end of 2008. Then what?
But you know what? That's a good problem to have.
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Someone has to be ready to buy and turn around Microsoft when people won't put up with them any more!
Posted by: Michael N at March 10, 2007 03:49 PM
I think Apple is better off not creating one not because of financial reasons but I think an Investment fund would appear to everyone as a marketing extension and might just muddle the waters. Each funding would imply an implict gathering into the high gates of Apple, Inc. - and that would affect people's perceptions outside the gates because Apple the name/comapny carries a lot of weight and preconceptions (good or bad) - that it's Mac only - that it's a secret - that it will get a nice overcoat of Apple' UI, Jonathan Ive will clean up the finla design, etc, etc ... for potential employees, they will always think - will it just be absorbed into a secret Apple project without an IPO? Will it be Mac only so I'll never get the full money payback, etc, etc ... none of it might be true but why go into the waters to create potential problems - isn't it better just to sit back - let the angels and VCX's get in on the ground floor and build out to whem they are actually ready to go prime time? Apple can afford almost anybody in it's first two years of existence (<$500 MM is nothing to Apple) so why waste time funding 11 guys who can come up with a better video codec when you can pick from the 11 best and just write one slightly bigger check?
Posted by: jbelkin at March 14, 2007 10:19 PM