The Activist Investor Blog
The Activist Investor Blog
Corporate Cash Hoarding and The Great Recession
How badly could the US economy could have used almost $1 trillion in spending and investment last year?
Blame abounds for the previously-dead-but-only-slowly-reviving economy: profligate Wall Street, a confused Federal Reserve, strapped consumers, and of course the clueless White House. How about US corporations and their leaders? They oversee a cash “hoard” (to use the term from an op-ed in the Wall Street Journal, and which we previously discussed) that dwarfs the infrastructure and tax cut plans bandied about last year, and handily exceeds the 2009 stimulus package.
Yet, risk averse corporate executives sit on that cash, too scared to spend it. Then, they turn reckless, and these days wait expectantly to spend (or waste) that cash on value-destroying but ego-feeding mergers and acquisitions. To see this, merely think about their corporate balance sheets as we smart investors do.
The Federal Reserve reported at the end of October that US corporations (other than banks and other financial services companies) held over $1.9 trillion in cash and liquid securities, a 26% increase over the year-ago level and the highest level in almost 50 years. Wise investors ask, why do companies need cash at all, and how much do they truly require?
Corporations have two reasons to hold cash:
❖to fund fluctuations in daily, weekly, or monthly operations
❖to invest: in research and development, in growth.
Investors widely believe that risk averse managers routinely keep much more operational cash than makes economic sense. CEOs worry, needlessly, that they require many months’ worth of reserves when at most several weeks’ worth will do.
Then, these managers turn careless, and waste much of the cash that they do invest, like a teenage shopper at the mall with a paycheck burning a hole in her pocket. Countless academic studies demonstrate the folly of corporate deal-making.
Look at Microsoft, which has for years attracted attention from investors for its substantial cash balances. Eric Jackson of Ironfire Capital last year submitted a resolution to the company that calls for a dramatic increase in their quarterly dividend, thus transferring a chunk of that cash from managers to investors.
As of December 2010 Microsoft held about $31 billion in net cash, after paying off $10 billion in debt. The company’s day-to-day cash needs hardly vary; it’s a veritable cash flow machine. I estimate they need a cushion of a couple billion or so dollars, in case collections slow down temporarily, or expenses spike a bit. Call it $3 billion.
So, they have an extra $28 billion or so on hand, ready to spend on…what? A bidding war with Google or Apple for some attractive technology similar to the one that Dell and Hewlett-Packard fought for 3PAR?
If management pays out some of that cash to hungry investors, they company will hardly miss it. What does it need that it can buy with $28 billion that it can’t buy with $10 billion or $15 billion? More to the point, what should investors allow them to buy with even $5 billion? Blessed little, based on most corporations’ M&A track records.
Experienced investors have gone through this with management and directors at almost every other US public company, who all think and act similarly. Although not as big as Microsoft, most US corporations hold cash balances in similar proportions. While estimates vary, a conservative but fair analysis suggests that corporations hold more than twice what they need to fund even unusual variation in operations. Pleas to return the extra cash to investors typically fall on deaf ears.
Where does all this extra cash sit right now? In the bank, of course, where lenders do anything but lend these days. It earns a meager money market return for these corporations, and us investors. It does investors, and now the US economy, little good there.
Suppose CEOs really listened to shareholders, and paid out as dividends and share repurchases the cash they can’t use now, and don’t really need. How about we investors split it with them, and let them keep half of the $1.9 trillion for themselves? That’s over $900 billion in investable cash that shareholders will spend much more quickly, and at least as wisely, than risk averse-then-reckless executives will.
Executives have rarely shown that they can spend money as well as investors. They also deprived the economy, as well as investors, of billions of dollars in badly-needed funding.
Tuesday, March 8, 2011