For years the question of what to do with excess cash has always been the same: Does a CEO invest the capital in R&D hoping for a possible return? Does the individual simply return it in the form of dividends to shareholders? Sit on it for as long as possible (and in today’searn about 1%)? Or does the CEO take the risk and begin making ?
Historically, this dilemma typically arises as the economy swings out of a recession. Having slashed expenses during the downturn, strategics usually have excess cash available during the early phases of a recovery.
This is especially the case during the current recovery. In past articles we have discussed the record amount of cash that corporate strategics are sitting on. Estimates vary, depending on the source, from over $1 trillion to up to $1.9 trillion. According to Cap IQ, as quoted in a recent article in TheDeal.com:
“As of March 31 of this year, 376 strategics on the S&P 500 had about $1 trillion in cash on hand, compared with $893 billion in cash from 2010’s first quarter.” (emphasis added)
If you do the math, the increase between Q1 2010 and Q1 2011 (for these 376 strategics alone) is 12%. Even in past recoveries, cash growth like this would have been seen as extraordinary. To have this much cash on balance sheets right now is truly remarkable.
So What’s A CEO Supposed To Do?
So again, the question arises, what to do with all this cash? There are essentially six options available to CEOs:
- Sit on it. Earn what you can and play it safe. This does not please shareholders. There are also potential tax ramifications to this strategy that may negatively impact the corporation.
- Return it. Give it back to shareholders in the form of dividends. In the long run, this is not what shareholders want either (in most cases).
- Buy back shares. Again, for some investors this will be positive; however, over the longer term, shareholders will look for more aggressive use of this cash than simply the company investing in itself.
- Invest it in equipment and expand. This would be a great option coming out of most recessions when the economy typically heats up and grows by 5-6% for several quarters. Given projected 2-3% GDP growth for the foreseeable future, using much of your capital to pursue this option is not optimal (certainly this will occur though as strategics will look for every avenue for growth).
- Invest in R&D. This can be very risky and take decades to produce a return. Although critical for some industries, for many companies it isn’t the best use of these funds, especially when you can acquire proven R&D via acquisitions.
- Acquire synergistic fits. Certainly there are risks associated with this option. However, given our expected anemic economic growth, it actually is the fastest and most efficient way for a strategic player to gain market share, expand geographically, gain access to new equipment and technologies and ultimately, improve earnings.
According to Dealogic, it appears that CEOs are beginning to choose this last option more frequently:
“About 16,000 global strategic deals have been announced so far this year, representing $1.1 trillion in transaction value. For 2010 more than 37,000 global strategic deals were announced, with close to $2.3 trillion in value. This was an increase from the nearly 34,000 global strategic deals announced in 2009, with about $2 trillion in transaction value.” (emphasis added)
So based on year-to-date (YTD) numbers through May, it appears that on a worldwide basis, strategic deal volume will be up about 4% this year (strategic deals are trending to end the year at 38,400). Although because the fourth quarter of every year represents a significant percentage of each year’s deal closings, I would estimate that we will be well above the projected 4% increase this year.
The same is true of the YTD transactional value numbers. The trend so far this year looks like globally we should easily reach $2.64 trillion in transactional value, a substantial 15% increase over 2010. However, with a strong fourth quarter this year, the worldwide numbers should be well above that. And as you look at these 2011 projected increases, keep in mind that they are coming off a very strong year in 2010.
Cash = Acquisitions
So despite the skeptics who are concerned about an M&A bubble – where valuations rise too quickly, overheating the market – most industry observers generally believe that spending cash on acquisitions rather than pursuing the other options listed above can be an effective way for corporates to quickly gain scale. Or as Ropes & Gray LLP partner Chris Comeau put it. “It [corporate acquisitions] is an easier way to grow rapidly.”
That last statement by Mr. Comeau is really the key to this entire discussion. Given that organic growth, which will be driven by lackluster GDP numbers, will be very slow for the next two to three years, acquisitions will provide strategic players with the best way to expand their cash flow.
So the question CEOs around the world face today, is an age-old one amplified by $1 trillion to $1.9 trillion in excess cash: Where to put it to earn the optimal return?
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