Capital Ideas: Unsightly Cash Buildup?

The stockpiles of cash on balance sheets could make it a buyer's market for CFOs who want to finance their companies' growth.

As corporations move into the new year, hoarding cash seems to be in vogue.

Short-term cash and equivalents rose 11.2 percent for the S&P 500 in the third quarter compared with Q3 2003, according to analysts at Reuters Fundamentals, the research arm for the business-information company.

Furthermore, a new survey from Fitch Ratings, which polled 412 investment-grade industrial companies in the United States, revealed that cash on the balance sheet jumped 9 percent in a year-to-year, third-quarter comparison. Fitch also reported that cash reserves for those companies covered a “comfortable” 25 percent of total debt outstanding.

The cash cushion could make the first part of 2005 a buyer’s market for CFOs seeking to borrow money to finance their companies’ growth, said Robert Knapp, chief financial officer of Siemens Financial Corp., the lending arm of Siemens AG. “Most companies are stockpiling cash…which puts lenders in a position of having to convince clients to finance equipment purchases or other growth without tapping their cash,” he added.

But coaxing CFOs to borrow funds when their companies are cash-rich and not focused on raising debt is a tough sell, according to Bill Davis, president and CEO of asset-based lender Congress Financial. Dangling low interest rates or advantageous debt restructuring deals in front of finance executives won’t tempt them to borrow funds if they’re not looking to increase their debt load, he said.

Davis also predicted that CFOs will spend their companies’ cash judiciously in the first part of 2005, mainly because many still worry about the fiscal effects of the war in Iraq, terrorism, and the economy. What’s more, year-end layoffs by major companies — including General Motors Corp. and Colgate-Palmolive Co. — reveal a corporate focus on reining in expenses, not firing up big growth plans, according to the lending executive.

Nevertheless, companies will start to unload their cash as the year goes on, albeit slowly, according to Davis. He and other experts agree that cash will be funneled into three main areas in 2005: capital expenditure (capex) spending, mergers and acquisitions, and dividends. If the activity at year-end 2004 is any indication, then the predictions are on target.

For example, Fitch announced a 2.7 percent increase in capex for the third quarter of 2004 over the same period the previous year, “the first truly meaningful growth in the metric since 2001,” said analysts there. Also, the number of companies reporting increases in year-over-year capex reached a six-year high of 61 percent; in 2002 that aggregate was at a low of 38 percent.

In 2005, cash will also be routed into acquisitions, reckons Jack Hoekstra, executive vice president of Northfork Business Capital Corp. “It’s likely that [companies have had] acquisitions on their plates for quite a while,” and the current M&A activity indicates further corporate consolidation, adds Hoekstra, who’s also president of the Commercial Finance Association, the trade group representing asset-based financing companies.

Hoekstra thinks that low inflation and what he sees as a slow, upward economic recovery will support M&A deals as the year progresses.

Still, 2005 looks like it will start off with an M&A bang, if you consider the mergers announced last quarter. The activity, after all, included deals between Sprint Corp. and Nextel Communications Inc.; Symantec Corp. and Veritas Software Corp.; and Johnson & Johnson Inc. and Guidant Corp.

Other evidence of a merger surge comes from bellwether dealmaker Goldman Sachs Group. The investment bank reported that its fourth-quarter net revenues for financial advisory services hit $414 million, a 37 percent jump from its 2003 fourth-quarter total. Officials at the firm say the rise reflects an increase in industrywide completed mergers and acquisitions.

Meanwhile, Goldman’s net revenues for its fourth-quarter investment-banking business rose 19 percent over last year, which it also attributed to increased M&A activity.

Some companies used their cash to reward shareholders with dividend increases. Late-year dividend distributions included a healthy 50 percent quarterly hike for Wolverine World Wide Inc.; a 25 percent quarterly increase for California utility Edison International; a 21 percent dividend raise for investment firm T. Rowe Price; and a 20 percent increase for cruise giant Carnival Corp.

As for December stock buybacks, Wendy’s International Inc. spent $53 million of its cash to repurchase 1.4 million common shares, while Ditech Communications Corp. approved a $35 million share buyback.

Despite last year’s late burst of spending momentum, however, many companies are likely to continue to hoard cash for the simple reason that it makes their annual financial statements “look pretty inviting” to stockholders, vendors, and lenders, said Northfork’s Hoekstra. “Many good CFOs will do that,” he added.

Marie Leone’s “Capital Ideas” column appears every other Thursday. Contact her at MarieLeone@cfo.com.

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