The Cash Trap

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

Finally, BCG suggests that companies make their strategy as transparent as possible. Doing that is something Gordon Coburn credits for helping Cognizant, which presents at more than 30 investor conferences a year, earn a higher multiple than its peers.

The ultimate reward for all that hard work should be an investor base that believes in the company’s long-term potential. “There’s a lot to be said for getting a base of investors that really understands and appreciates long-term results,” comments MEMC senior vice president and CFO Ken Hannah. “They’re not the ones calling you every time your numbers are plus or minus some minute amount.”

Randy Myers is a contributing editor of CFO.

Avoiding Cash Traps

In their efforts to balance short-term investor expectations with long-term strategic goals, The Boston Consulting Group (BCG) warns companies to avoid four cash traps that can have a negative impact on their near-term shareholder returns.

1. The Lazy-Balance-Sheet Trap

Companies that ignore investor pressure for near-term returns run the risk of reducing their valuation multiple and jeopardizing their independence. While public companies probably can’t get away with leveraging their balance sheets as highly as a private-equity owner would, many will find they can squeeze out cash for stock buybacks or dividends without jeopardizing their long-term goals. Some, of course, will be able to justify holding a bigger cash cushion than others. MEMC Electronic Materials Inc., a $1.5 billion maker of silicon wafers that delivered an annualized TSR of 62 percent over the past five years, announced a $500 million stock-buyback program in June but remained committed to maintaining a strong balance sheet. At the end of June it had $996 million in cash and short-term investments on hand, and just $26 million in long-term debt.

“I don’t consider that to be a lazy balance sheet,” says MEMC senior vice president and CFO Ken Hannah. “We’re in an industry that tends to be very cyclical, and I consider our position to be prudent.”

2. The Reinvestment Trap

Beyond deciding how much to reinvest in their business and how much to return to shareholders, companies also need to be smart about how they reinvest for long-term growth. Companies fall into a reinvestment trap, BCG says, when management misallocates resources across the business portfolio — either by feeding all businesses at the same rate despite their differing growth prospects or contributions to shareholder return, or by allocating too much capital to problem businesses.

3. The M&A Trap

Acquisitions are highly appealing, especially when they are immediately accretive to earnings. But an accretive deal won’t necessarily boost shareholder returns if, as is possible, it also reduces the acquirer’s multiple. BCG cites the example of a consumer-brands company whose CEO engineered the purchase of numerous low-tier, low-margin brands. The acquisitions boosted earnings in the first year but diluted the company’s average organic growth rate and margins, causing investors to drive down the multiple on the company’s stock and ultimately yielding no improvement in shareholder return.

4. The Stock-Buyback Trap

BCG doesn’t discount the role that stock buybacks can play in boosting near-term returns for some companies. But the firm’s research indicates that buybacks do not change investors’ estimates for long-term earnings-per-share growth, or induce them to accord a company a higher valuation multiple. By contrast, it says, dividends have a far more positive long-term impact. In a study of 107 companies that boosted their dividend, and another 100 that announced an increase in share repurchases, the dividend payers saw their multiples go up over the next two quarters by an average of 28 percent, and the top-quartile performers by an average of 46 percent. In comparison, the buyback companies saw their valuation multiples erode on average, and top-quartile improvements averaged only 16 percent. — R.M.


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