Add to that the drying up of bond markets and high volatility in equities, and holding on to your cash seems highly responsible. “No one asked me once last year whether we would make it through the recession,” says David Goulden, CFO of EMC, which had $10.2 billion of cash on its balance sheet against only $3.1 billion of low-interest debt at the end of its first-quarter. “The important thing is that we have lots of cash because we generate lots of cash.”
The Case Against Cash
But keeping cash on the balance sheet still carries significant costs and risks. They include, for starters, extremely low returns in vehicles like money markets; less use of financial leverage, which can improve gains to shareholders; and an open invitation to leveraged-buyout practitioners.
Also, a cash-laden company runs the risk of having its investors undervaluing it. “Investors may be scared of what management is going to do with that money,” says Gregory Milano, chief executive of Fortuna Advisors. “If the company has a track record of poor returns in its main business or bad and overpriced acquisitions, the market may value the cash at just 60 to 70 cents on the dollar.”
A cash-heavy balance sheet also increases conflict between shareholders and management. Idle cash is an escalating issue for boards of directors, says James Ellis, managing director in the finance operations consulting group at Accenture. “There are a growing number of board-level discussions where the C-suite is being pushed,” he says. Before, board members simply wanted to know whether a company had a plan for its cash; now, they want to see the actual plan, says Ellis.
But deploying cash goes beyond making a single action or deal. “CFOs have to figure out what sustainable [financial policies] work in this climate,” says Eric Olsen, global leader of the shareholder-value practice at The Boston Consulting Group. “That comes back to dividends, share repurchases, mergers and acquisitions, and investing in longer-term growth.”
Flexibility Versus Return
That last option, investing in growth, may be at the top of the referred list in theory, but overall capital expenditures will grow modestly this year and next, according to a May report from Fitch Ratings. Studying a universe of 308 U.S. companies, Fitch found that capital expenditure fell 16.6% in 2009. The companies plan growth of 3.1% this year, and only 1.4% in 2011. R&D projections in many industries are also paltry.
For high-growth, high-cash companies such as Cree, organic investments are eminently sensible. The market for LEDs is only 2% penetrated worldwide, says Kurtzweil, and governments are fast imposing standards that promote energy-efficient lighting using LEDs. The company received $39 million in tax credits from the American Recovery and Reinvestment Act, and raised $450 million selling common stock in late 2009. As of the first quarter, Cree had $990 million of cash and liquid investments.
Cree is quickly funneling that money into capital projects. Buying buildings and equipping fabrication plants will consume $250 million both this year and next, Kurtzweil says, a level necessary to pace the market’s growth and keep competitors at bay. “Time to revenue is key,” says the CFO. “The flexibility I get with my cash position more than offsets the low investment returns on my cash balances.”