Now, says Kulp, Transocean is wrestling with a decision: Should it continue paying down debt, start stockpiling some of its cash, pay a dividend, or buy back some of its own shares? “We’re focused on cash flow return on capital, and if there is not an investment out there that will produce a good positive CFROC, we have to look at other options,” says Kulp. “We made a tremendous investment in assets in the late 1990s and early 2000s when we built a number of fifth-generation rigs. They’re paying off for us now, and we don’t feel the need to go out and build new rigs for the sake of building rigs. We’re going to make sure that whatever we build will result in a good return on capital.”
Kulp’s views on deploying cash are hardly atypical, notes Bill Beech, a principal with Purchase, New York–based REL. “Managements are under a lot of pressure from analysts and shareholders’ groups about accountability,” says Beech. “Especially with the advent of the Sarbanes-Oxley Act, they’re under a lot more scrutiny, which has made them more cautious about investing.”
Randolph Roy, vice president and treasurer of $1.4 billion Moody’s Corp., the New York–based corporate credit-rating agency, concurs. “I think managements are more aware of making sure that whatever investments they make better add to shareholder value,” says Roy. “You’ve got to earn an appropriate rate of return, certainly one that is well above your cost of capital.”
Roy also suggests that managers may be more cautious about how they deploy their cash because the penalty for messing up has gotten stiffer. “Managements are much more aware that the [career] life of the executive, if he or she doesn’t perform, has gotten a lot shorter,” he says. Exhibit A: former Hewlett-Packard CEO Carly Fiorina, who was unceremoniously dumped from her post at the $79.9 billion computer and printer maker early this year, in part due to lingering discontent with the 2002 purchase of Compaq Computer. HP is still trying to digest that acquisition.
Moody’s itself dramatically built up its cash levels from 2002 to 2004, with its cash-to-sales ratio jumping to 42.1 percent from 3.9 percent. That put Moody’s well above the 2004 year-end average of 11.0 percent for the companies in the industrial and commercial-services sector in which it competes. According to Roy, the increase was attributable primarily to Moody’s being less aggressive than it typically has been about using its ample free cash flow to buy back its own shares. “We return quite a bit [of cash] through share repurchases,” he says. “In the past couple of years, though, we have not been as aggressive about our buybacks.”
Of course, Moody’s has not had much of an opportunity. From January 2003 to the end of July 2005, its stock rose from just under $22 a share to more than $47 in virtually a straight line. Still, Roy says the company plans to become more “systematic” in its approach to buybacks, suggesting that going forward, it won’t wait for a decline in price to repurchase more shares.