The Cash Trap

Cash may be a comfort in an uncertain economy, but it can also be a drag on shareholder value.

In this environment, investors either hold back on giving a cash-rich company’s stock its full due or push for a way to get that money into their own pockets, typically through a stock buyback. If management won’t pull the trigger, private-equity firms and activist investors are happy to do the job. The challenge, then, is for companies to satisfy their investors’ short-term expectations while retaining enough resources to execute long-term strategy — without stumbling into what BCG calls a “cash trap” (see “Avoiding Cash Traps” at the end of this article).

Opportunity Costs

Ironically, the easy money of the past few years, a byproduct of rising corporate profits and stock prices, is in some ways limiting the options available to corporate managers. In too many industries, it has allowed for too much cash chasing too many growth opportunities. “There are private-equity deals getting done in industries that never would have been candidates for private equity in the past, at pricing that probably wouldn’t have made sense in the past,” observes J.D. Sherman, CFO of Akamai Technologies Inc., a $429 million Internet services firm in Cambridge, Massachusetts.

Still, it’s not surprising that companies are trying to do something with their cash. Assuming aftertax returns on cash of 3 to 4 percent, and market-average returns of 10 percent on a stock index fund, the forgone opportunity cost for investors is 6 to 7 percent. “That opportunity cost,” writes BCG in “Value Creators,” “has a negative impact on annual TSR of one to two percentage points, on average, which over 10 years is equivalent to the difference between top-quartile and average performance.”

Many companies have, of course, turned to stock buybacks. Through the end of last year, companies in the S&P 500 had bought back more than $100 billion in shares in each of the past five quarters, nearly double what they were paying out in dividends. There’s some logic to that, says BCG, given that many companies are carrying cash and excess debt capacity equal to 20 to 30 percent of their market capitalization. Still, BCG argues that buying back stock doesn’t deliver much in the way of long-term value, meaning that corporate executives must still find ways to differentiate their companies from their competitors and demonstrate that they can deliver profitable, above-average growth.

Some, like Widman and his C-suite colleagues at Terex, seem to have mastered the challenge. “Five to 10 years ago, we were a company still trying to prove ourselves,” Widman says. “We had made several acquisitions, and investors were still asking themselves whether we could integrate and operate them effectively. Over the past 5 years, though, I think we’ve built up sufficient credibility that we have earned the right to pursue our long-term strategy. And I think that’s part of what’s created the increase in shareholder value that we’ve seen.”

Cognizant Technology Solutions Corp., a software-services and data-warehousing provider in Teaneck, New Jersey, did even better with an annualized TSR of 62 percent. Over the past five years, it grew its sales from $178 million to $1.4 billion and increased earnings more than 10-fold. It has no debt on its balance sheet, only just announced its first stock-buyback program, and has limited its acquisitions in recent years to small, strategic buys — companies that could expand its geographic reach into a new niche or provide access to technologies or industry knowledge.

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