There is at least one upside to the current bout of market volatility: It should give financial engineering a bad name.
Okay, financial engineering has never exactly coasted on a good reputation – given that it tries to boost asset prices with balance-sheet tinkering rather than improved corporate performance – but it is now looking downright dangerous.
Apple Inc. offers a clear example, given the dismal performance of its bonds since acquiescing to engineering types, namely hedge fund manager David Einhorn, earlier this year.
In April, Apple announced a $17-billion (U.S.) bond offering as part of a $100-billion plan to boost its dividend and fund share buybacks over the next few years without having to repatriate overseas cash at a high tax rate.
Investors loved it: Apparently, demand for the bonds reached $50-billion, even though the yield on the 10-year bond was just 0.75 percentage point above the yield on the comparable U.S. Treasury bond.
Mr. Einhorn also loved it: He reportedly increased his stake in Apple soon after the bond sale was conducted. “This is a vastly more shareholder friendly capital-allocation policy than where Apple stood a few months ago,” he said on a conference call in May. “We’ve added to our Apple position. Now we just wait for the release of Apple’s next blockbuster product.”
Unfortunately, his enthusiasm marked the start of a stunning rise in bond yields, which has made Apple’s capital-allocation policy look like an ugly divergence from, say, a new iPhone.
The yield on the 10-year U.S. Treasury bond surged above 2.6 per cent early on Monday. Though the yield settled back to about 2.56 per cent, it is still well above a yield of 1.63 per cent seen near the start of May.
Apple bonds have moved with the Treasury bond. The yield on Apple’s 10-year bond (issued with a coupon of 2.4 per cent) has risen to about 3.56 per cent from a low of 2.33 per cent on May, soon after their debut. Put another way, bond prices have fallen – not out of concern about Apple’s credit-worthiness but because of a higher interest-rate environment.
Apple’s 30-year bond has made an even more pronounced move. According to the Financial Times, the falling price on the bond has dealt day-one investors a 13.5-per-cent loss, which is far worse that the slide of the S&P 500 from its peak in May.
And what has the bond issue done for Apple’s stock? Not much, it seems: The shares dipped below $400 on Monday, closing at $402.54, down $10.96. They are now close to their 52-week low, or about 43 per cent below their record high last year.
Peter Misek, an analyst at Jefferies, cut his target on the stock to $405 from $420, arguing that Apple will build a maximum of 85 million iPhones in the second half of 2013, down from an earlier estimate of 110 million, according to Bloomberg News.
At the same time, the iPhone and the iPad appear to be losing their cachet among consumers – and investors – who want to see Apple deliver something new that puts the company back at the forefront of consumer innovation. That’s a problem financial engineering can’t solve.