News: Analysis & Commentary: CORPORATE FINANCE
U.S. COMPANIES ARE PILING UP CASH. IS THAT A PROBLEM?
For some companies, it's `an enormous temptation to waste'
What a windfall. On Jan. 27, General Motors disclosed that it ended 1996 with cash reserves of $17 billion--$2 billion more than analysts had expected and some $4 billion more than the company says it needs as a cushion against future economic downturns. GM attributed the late-year cash surge to a well-timed tax refund and better management of inventory and receivables. Result: what GM Chief Financial Officer J. Michael Losh calls "an absolute powerhouse cash position."
There is, however, a larger trend at work. "In company after company, we're seeing huge buildups of cash," says Jeffrey D. Fotta, CEO of Ernst Institutional Research in Boston. Tech companies Intel Corp. and Microsoft Corp. ended 1996 with $8 billion and $9.2 billion in cash on hand, respectively. Auto makers Ford Motor Co. and Chrysler Corp. are sitting on record reserves of $15.4 billion and $7.8 billion. Even many smaller companies ended the year flush with money. California biotech outfit Alza Corp. had nearly $1 billion burning a hole in its pocket at yearend, partly from a $500 million debt offering last April. All told, liquid assets held by U.S. nonfinancial companies hit a staggering $679 billion at the end of the third quarter, up 21.5% in a year, figures Deutsche Morgan Grenfell.
Cash-rich coffers, of course, are a natural outgrowth of a healthy economy and soaring profits in the wake of restructuring. But too much money creates a vexing problem: what to do with it. "Having that much cash is an enormous temptation to waste," cautions Steven N. Kaplan, a professor of finance at the University of Chicago's business school.
DON'T SIT STILL. Many executives agree. DuPont Co. has about $1.3 billion stockpiled, not a huge hoard for a company with $45 billion in annual revenues. "We're not a bank and we're not here to buy Treasury notes," says Kurt M. Landgraf, DuPont's CFO. He says DuPont needs reserves for acquisitions and expansion but contends "it's not a good thing to have tremendous amounts of cash on hand."
That's why the nation's more agile dealmakers rarely sit on cash for long. HFS Inc. had $471 million stockpiled as of the end of the third quarter but quickly spent the money on deals such as its buyout of Avis Rent A Car. Acquisitions provide "a much higher return on investment than T-bills," snipes HFS CEO Henry R. Silverman.
Bigger companies are pouring money into overseas expansion. Chrysler Chairman Robert J. Eaton, for instance, says his company will be able to finance its five-year, $23 billion product development through operations, saving cash for new growth, especially abroad. GM plans to put close to $3 billion into overseas capital expenditures in 1997.
The worry is that many companies are taking on cash so fast they can't spend it efficiently. Intel, for instance, has historically aimed to keep enough money on hand to build two chip factories; today, it has twice that level of cash in its coffers. Strapped for other things to do with its money, Intel made $1.3 billion in stock buybacks in 1996. Microsoft is using up some of its cash pile to buy fast-growing, mainly Internet-related companies that can potentially produce outsize returns. But do such acquisitions distract management from business fundamentals?
Wary of that risk, executives are rushing to increase payouts to shareholders. Some 2,171 companies raised dividends last year, out of 2,301 reporting to Standard & Poor's Corp.--more than in any year since 1980. But with stock prices surging, yields are still at a historic low of just 2.02%. That's why many are augmenting higher dividends with massive share buybacks. Nearly 1,500 companies announced a record $176 billion in planned stock buybacks last year, says Securities Data Co. Chrysler has spent $3.1 billion since 1995 to buy back 112 million, or 14%, of its outstanding shares--$2 billion in 1996 alone--and plans to spend $2 billion more this year on buybacks. Hewlett-Packard, Gap, General Electric, and Citicorp also announced big share-repurchase plans last year. GM plans a big one this year.
SMOOTH GROWTH. In most cases, companies still have plenty of money left over after the buybacks. IBM, for one, is "awash in cash," notes Michael A. Metz, chief investment strategist for Oppenheimer & Co. Big Blue finished 1996 with $8.1 billion in ready funds on hand, up from $7.7 billion at the end of 1995. Yet during the year, it spent $6 billion on capital expenditures, $1 billion on acquisitions, and $6 billion on share repurchases. All told, IBM has spent some $10.7 billion on stock buybacks since 1995. "That has been an important contributor toward growing our earnings-per-share in that time frame," says CFO G. Richard Thoman.
Why is this huge cash buildup happening now? After years of restructuring, corporate balance sheets are bearing fruit. "Companies are better managed, and they're returning strong earnings and lots of cash," says Abby Joseph Cohen, market strategist for Goldman, Sachs & Co. Restructuring has boosted earnings at a much faster rate than revenue growth. But fearing a coming slowdown, companies are also throttling back capacity expansion, leaving them sitting on excess cash.
Some companies, such as Boeing Co. and the Big Three auto makers, plan to keep huge cash reserves to see them through the next economic downturn. Ford, for instance, calculates its net cash by subtracting its debt from total cash; the resulting amount is less than the company's "above $7 billion" target, says CFO John Devine. That makes a big dividend boost or stock buyback unlikely from Ford this year. Companies in cyclical businesses learned the hard way last time. "Can you ever have too much capital?" asks Maurice R. Greenberg, chairman of insurance giant American International Group Inc., who continues to add to his company's coffers. Like many execs, he thinks not.By Andy Reinhardt, with Linda Himelstein in San Francisco, Joseph Weber in Philadelphia, Kathleen Kerwin in Detroit, and bureau reports reportsReturn to top