Time to Get Off Your Cash?

Companies are content to sit on their cash hoards, but investors are losing patience. What's a CFO to do?

The company’s earnings aren’t suffering. Its gross profit margin hit 48% in the first quarter, and even with the large cash balance, return on equity rose from 1.4% one year ago to 9.5% in the first quarter. Kurtzweil’s position is a conservative one, but he says using cash instead of bank debt, preferred shares, or high-yield bonds leaves the latter avenues of financing open in the future.

Eighty percent of Cree’s sales are overseas, and that will be common as U.S. companies look to emerging markets with explosive growth in gross domestic product. But BCG’s Olsen says that could be a recipe for problems at cash-rich companies. Too much cash could chase fewer opportunities as economies like China, Indonesia, and India mature, Olsen explains, leading to bidding wars, overinvesting, and lower returns.

A number of multinationals hold stockpiles of cash overseas, since repatriating income earned by foreign units would incur U.S. taxes. For example, at the end of its fiscal 2010 second quarter, Cisco Systems had $39.6 billion in cash and cash equivalents, but only $8.8 billion was held within the United States.

M&A: All Talk?

By far the most common reason cited for holding cash is financial flexibility — specifically, retaining it to buy companies. After all, cash is highly attractive to a seller, allowing its owners and investors to immediately exit. In an April 2010 survey by BCG, 43% of fund managers and other investors said strategic M&A should be the highest or second-highest priority of companies with excess cash.

Indeed, many CFOs say acquisitions are on the horizon, although in June the dollar volume of deals by U.S. domestic companies was at its lowest year-to-date level since 2003, according to Thomson Reuters. “Prudence doesn’t make for an exciting equity story, so many CFOs feel obliged to highlight growth strategies and make allusions to M&A opportunities — never mind that many of them don’t have proven records on the M&A front,” comments Justin Pettit, a partner at Booz & Co. Overall, though, Pettit thinks it’s more than just talk; he’s now seeing a great deal of activity on growth-strategy development, target screening, due diligence, and postmerger integrations.

Cash stores are hitting a 10-year high.

Does it pay to use cash as consideration? With financing markets for deals still difficult and covenants more restrictive, tapping cash reserves is a good option. Likewise, if a buyer doesn’t feel its shares are fully valued, paying in cash makes financial sense. Using cash forces more discipline around the purchase price, so it can prevent a company from overpaying. “If we can use cash we generate from the business, we’re not diluting our shareholders — they wind up owning the same percentage of a bigger company,” says EMC’s Goulden.

One of the largest cash balances among Internet software and services firms in the CFO Midcap 1500 resides at Akamai Technologies, whose content-delivery network speeds up Web applications. The company’s cash level hit $1.1 billion in the first quarter, more than 100% of annualized sales, up from $849 million in the first quarter of 2009.


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