Apple's Collapse: A Scholarly Perspective

...During the first decade of the 21st century, Apple was an exception to the rule of the financialized corporation in the United States. Now, it seems, it is not.

NEW YORK ( TheStreet) -- Over the long weekend, I did one of the things I miss most about being a graduate student. I rediscovered there's no good reason why a PhD dropout can't read academic literature as often today as he did when he was knee-deep in academia.

In fact, financial media needs more journalists who, on some level, marry popular and academic approaches or, at the very least, add rigor to their own work by consulting scholarly research. What passes for "research" on Wall Street -- data sprung from convenience samples drawn by half-cocked analysts such as BTIG's Rich Greenfield -- wouldn't make it past the most lenient journal referee without the necessary author admissions, explanations and disclaimers.

Seeking an elevated level of rigor matters even more as the conversation around battleground companies and stocks such as Apple ( AAPL) continues to devolve.

In this article, I summarize and discuss Apple's Changing Business Model: What Should the World's Richest Company Do with All Those Profits by University of Massachusetts-Lowell professor William Lazonick, University of Sussex professor Mariana Mazzucato and research associate at UMass-Lowell's Center for Industrial Competitiveness Öner Tulum. Their article is forthcoming in Accounting Forum, but available now at The Academic-Industry Research Network's Web site.

Throughout this article, portions of their work appear in italicized block quotes.

I do my best to relay the academic argument in key, sometimes lengthy excerpts, but, as is the case with most popular media portrayals of academic work, I can't help but fall short. You really need to read the entire paper.

First, because it's fantastic. Second, because it provides so much necessary context that I had no choice but to leave out, from historical support to the authors' theoretical framework to a useful list of references.

And third, because the work comes from academics, not journalists, it might just get through to even the most ardent AAPL bulls. These are the people, particularly the company's CEO, who continue to desecrate Steve Jobs's legacy.

Chide the ivory tower all you want, but you can't accuse professors of creating "click bait" to generate "page views." Academics aren't in the business of getting page views. A very small number do and an even smaller segment make real money off of any unusual mass exposure.

On Page Two, I summarize the core of the authors' main points.

The Thesis

And, as we shall argue, since the death of Jobs, under his successor as CEO Timothy D. Cook, important changes in Apple's business model have occurred that suggest that Apple's innovative capability will be much diminished in the future.

The beauty of this paper might just be that, early on, the authors address the number one criticism in response to the notion that, without Steve Jobs, Apple cannot possibly repeat the success of iPod, iPhone and iPad. But they don't simply address it. Building on their theoretical and empirical work, they take the Jobs-Cook dichotomy to another level.
However, to reduce the Apple story to the Jobs story would be to ignore the particular concatenation of social conditions that have underpinned the company's innovative success. To summarize our main argument, in his position of strategic control, Steve Jobs led Apple as a professional manager, not an owner, who was driven by the desire to produce superior digital devices that would find widespread demand, even at premium prices, in mass markets. The internal learning process that resulted in Apple's epoch- making digital devices entailed a high degree of organizational integration of large numbers of people with a wide-range of functional specialties and hierarchical responsibilities. This organizational integration was fundamental to the development of the technologies that underpinned Apple's growth. For Jobs, profits were a vital source of financial commitment for innovative investment strategies, not an objective of the firm. Unlike John Sculley, Apple CEO from 1983 to 1993, Jobs had little if any interest in distributing earnings to public shareholders. Jobs installed what Lazonick and O'Sullivan (2000) have called a "retain-and-reinvest" allocation regime.

Social conditions. The inclusion of these "things" many businesspeople have a pre-disposed tendency to ignore, in and of themselves, elevate the rhetoric to a higher, more righteous level. Retain profits. Retain great employees. Reinvest in what brought you to the dance.
Apple's policy of "maximizing shareholder value" under Sculley's reign did not end well. In 1994, after having spent $273 million on stock repurchases in 1993 alone even as profits declined sharply, Apple was compelled to make a long-term bond issue of $297 million ...
When Apple went public, the private-equity interests cashed out handsomely. We can also assume that the public shareholders who bought stock in the 1980 IPO sold their stakes over the ensuing years to secure a healthy capital gain. Apple's employees have bought large amounts of Apple's stock as part of their stock-based remuneration systems: $5.0 billion from 2004 through 2012, which were dwarfed, however, by profits of $101.9 billion over this nine-year period ...

Another point we overlook in favor of the conventional, widely accepted and errantly intuitive principle that when you buy stock in a company, you purchase a "say" in what happens and are somehow entitled to reap monetary benefits beyond the capital gains you might realize if the stock price increases.
Hence the only time that Apple raised new funds from public shareholders was in its IPO in 1980, and those shareholders have long since reaped their returns on that investment. Indeed, when Apple's stock repurchases are taken into account, over its history the company has bought far more stock from public shareholders than public shareholders have bought from it.
Yet now that Apple has accumulated an enormous cash reserve, public shareholders are demanding that Apple "return" capital to them. In July 2012 Apple paid $2.5 billion in dividends, it first such payout since October 1995 (not shown in Figure 6 because its size would make it difficult to read the historical series). Since then Apple has been paying dividends every quarter for a total of $7.8 billion in the first three-quarters of fiscal 2013. Apple also expended just under $2 billion on buybacks in the second quarter of 2013, and, under its $60 billion repurchase program, expended $16.0 billion in the third quarter of 2013.

Here's how Lazonick et al. characterize the David Einhorn situation, which ultimately led to Tim Cook's decision to give in and return cash to shareholders:
In September 2010, David Einhorn of Greenlight Capital, a major hedge fund, bought a stake of approximately 1.4 million shares in Apple at about $280 per share. When the stock price peaked at $705 in September 2012, Einhorn could have sold the stock for a $600 million gain. But he decided to hold on to the stock even as it plunged to less than $450 per share in February 2013.
By that time, Apple had liquid assets of $137 billion on its balance sheet. Greenlight wanted to get its hands on a chunk of that cash (bold emphasis added).
In the highly financialized business environment of the United States, the Einhorns of the world, who have absolutely nothing to do with Apple as a company that employs people and produces products, now seem to have a preponderant influence in determining Apple's future.

While Einhorn was unable to push his iPrefs proposal through, he still won. He got what he wanted and, now, thanks, in part, to Carl Icahn he'll get more because the big money now runs the show at Apple.

According to the academics, here's how Apple should proceed:
Apple should ensure that resource allocation decisions are in the hands of people who have not only the ability but also the incentive to invest in innovative products that masses of people will want at prices that they can afford to pay.
Apple's executives should recognize that the most critical investments that the company can make are in teams of people who over the course of their careers can integrate their skills and efforts to produce superior products using superior processes.
Given its huge accumulation of liquid assets, Apple clearly has ample financial resources to invest in the information and communication technologies of the future.

In other words, enough of the Einhorn and Icahn sideshows. More of what brought you to the dance.
We cannot predict the future, but we can learn the lessons of the recent past. Evidence from the close study of the changing business models of other iconic cash-rich high-tech companies such as Intel (INTC), Microsoft (MSFT), and Cisco (CSCO) strongly suggests that when corporate executives who exercise strategic control become committed to "maximizing shareholder value" through massive stock repurchases they lose both the incentive and ability to invest in innovation (Lazonick, 2013a). Top executives lose the incentive to invest in innovation because, with their abundant US-style stock-based pay that typically rewards short-term boosts in stock prices, they are prime beneficiaries of stock-price manipulation through stock buybacks (Lazonick, 2009b). They eventually lose the ability to invest in innovation because they spend their time and effort thinking about extracting value that was created in the past rather than envisioning and implementing the innovative investment strategies that will create value in the future.
In the process these top executives adopt the language and mindset of value extractors such as Einhorn who, as quoted above, portrays his raid on the Apple corporate treasury as "unlocking shareholder value" and the particular method by which he seeks to get hold of this cash as a "value creation idea". Cook and the Apple board see themselves as "returning" cash to shareholders, even though the shareholders in question never invested cash in Apple in the first place.
Unfortunately, as demonstrated by the $100 billion (and potentially growing!) capitulation of CEO Cook and Apple's board to the activist hedge funds, incumbent management is deeply in bed with the value extractors.
In other words, Apple is becoming a typical American corporation. Scully et al. tried that back in the late 1980s and early 1990s, and failed. Steve Jobs came back to lead Apple to its current position as the world's most successful company by reinstating the social conditions of innovative enterprise. Now, however, shareholder-value ideology is far stronger than it was two decades ago, and Steve Jobs cannot return. With its new financialized business model, Apple appears to be quickly transforming from exceptional to ordinary. With the "end of innovation" no longer driving the company, we predict that the end of innovation will be Apple's fate.

There's not much I can add that I haven't said already. I just hope Tim Cook reads Accounting Forum or has access to the Internet.

-- Written by Rocco Pendola in Santa Monica, Calif.

Rocco Pendola is a columnist and TheStreet's Director of Social Media. Pendola makes frequent appearances on national television networks such as CNN and CNBC as well as TheStreet TV. Whenever possible, Pendola uses hockey, Springsteen or Southern California references in his work. He lives in Santa Monica.

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