CEOs Tap Record $940 Billion Cash for Dividends as M&A at Post-Lehman High
U.S. executives are starting to spend the record $940 billion in cash they built up after the credit crisis, just in time for annual shareholder meetings.
Takeovers topped $260 billion this quarter, the most since the collapse of Lehman Brothers Holdings Inc. in September 2008, according to data compiled by Bloomberg. Standard & Poor’s 500 Index companies authorized 38 percent more buybacks in 2011 than a year earlier and dividends may increase to a record $31.07 a share in 2013, data compiled by Birinyi Associates Inc. and Bloomberg show.
Chief executive officers are looking for ways to increase investor returns after posting the biggest gain in profits since 1988 by relying on near-zero Federal Reserve interest rates and cost cuts that have kept the unemployment rate near a 26-year high. More than 139 companies in the U.S. equity benchmark index are preparing for shareholder meetings in the next two months after the S&P 500 almost doubled in the past two years and as profits approach a record.
“Shareholders have raised the bar,” said Alan Gayle, senior investment strategist at RidgeWorth Capital Management in Richmond, Virginia, which oversees $45 billion. “Companies are going to have to find ways to generate more return,” he said. “The idea of sitting on idle cash in a zero interest rate environment is increasingly viewed as a nonviable option.”
More takeovers were announced last week than any time since March 2010 after AT&T Inc. (T) in Dallas offered $39 billion for Bonn-based Deutsche Telekom AG (DTE)’s U.S. wireless unit and San Francisco-based Charles Schwab Corp. (SCHW) agreed to buy OptionsXpress Holdings Inc. (OXPS) of Chicago for $1.11 billion in stock. Cisco Systems Inc. (CSCO), the world’s largest maker of networking equipment, said on March 18 that it will pay a quarterly dividend for the first time of 6 cents.
Companies in the S&P 500 have been piling up money for two years as per-share profit jumped 36 percent in 2010, the most in more than two decades, data compiled by Bloomberg show. The world’s largest economy is forecast to expand 3.1 percent this year, the fastest annual pace since 2005, based on the median estimate from 68 economists surveyed by Bloomberg.
The rate of U.S. growth in the fourth quarter was revised to 3.1 percent from 2.8 percent and consumer sentiment dropped more than forecast in March, according to reports on March 25. The Labor Department may say this week that U.S. unemployment remained at 8.9 percent in March, according to the median economist estimate tracked by Bloomberg.
The S&P 500 gained 2.7 percent to 1,313.80 last week, reducing its decline from a 32-month high of 1,343.01 on Feb. 18 to 2.2 percent. The benchmark gauge for American equities had fallen 6.4 percent through March 16 as investors speculated Japan’s earthquake would cripple its economy and uprisings in Libya and Egypt spurred concern fuel costs will stoke inflation. The stock index slipped 0.3 percent to 1,310.19 today.
Oil climbed above $106 a barrel in New York on March 24 as allied warplanes continued strikes against Muammar Qaddafi’s ground forces in Libya. In Japan, manufacturers started production at idled plants even as authorities struggled to seal radiation leaks caused by the March 11 earthquake and tsunami. European leaders met in Brussels after Portugal’s parliament rejected budget cuts and two officials with direct knowledge of the matter said the country may require a 70 billion euro ($98 billion) bailout.
Companies including Limited Brands Inc., owner of the Victoria’s Secret chain, are relying on debt to reward shareholders. The drop in borrowing costs to a three-year low has given executives the incentive to sell bonds and use the proceeds to repurchase stock and pay dividends.
The extra yield investors demand to own investment-grade corporate debt instead of Treasuries reached 148 basis points on Feb. 17, the lowest since October 2007, according to Bank of America Merrill Lynch index data.
At least nine borrowers had their credit ratings cut this quarter because they favored shareholders over bondholders, the most since the fourth quarter of 2007, according to Moody’s Corp. S&P reduced its outlook for Limited Brands to “negative” after the Columbus, Ohio-based company sold $1 billion of bonds last week to help fund its stock buyback.
“You’ve got to be careful going down that road,” said Brian Barish, president of Cambiar Investors LLC, which manages about $5.6 billion in Denver. “Companies can do some long-term damage to themselves by levering up to buy back stock just because they’re bullish on their stock when the market isn’t. Sometimes the market has it right and companies have it wrong.”
Companies increased cash balances in part by cutting capital expenditures 26 percent in 2009, the biggest drop since records began in 1998, according to data compiled by Bloomberg. Cash levels may start falling as analysts’ estimates show S&P 500 companies will boost spending on plants, property and equipment about 22 percent this year, the most ever.
“As the markets have recovered and access to credit has become readily available, issuers are increasingly looking to return capital to shareholders,” Greg Hall, a managing director in debt capital markets at Barclays Plc in New York, said in an e-mail. “As the economy continues to improve and corporations feel more confident in the future, we expect to see even more activity.”
S&P 500 Valuation
Equity priced below historical valuations is helping fuel mergers and repurchases. The S&P 500 trades at 15.4 times reported earnings, compared with an average of 16.4 since 1954, data compiled by Bloomberg show. Based on analysts’ forecast for 2011 profits, the index’s price-earnings ratio is 13.6, according to the data.
The value of takeovers increased 35 percent in the first quarter from the same period in 2010, data compiled by Bloomberg show. Acquisition prices exceeded market value by 23 percent on average, the smallest premium since the third quarter of 2007. That’s a sign to MFS Investment Management’s James Swanson that deals haven’t reached speculative levels.
“There’s a lot more vigilance on the part of shareholders, institutions and hedge funds about companies paying too much for acquisitions,” said Swanson, chief investment strategist at Boston-based MFS, which oversees about $230 billion. “Companies don’t want to overpay.”
While the stock market return for buyers in about half of the 100 biggest takeovers made between 2005 to 2008 trailed industry peers two years later, acquirers are seeing gains this year, data compiled by Bloomberg show.
DuPont Co. has advanced 8.7 percent since Jan. 9, after it offered 39.3 billion kroner ($7.41 billion) in cash for Danisco A/S, a maker of enzymes used in biofuels. The deal would be the biggest since 1999 for the third-largest U.S. chemical maker, which had $6.8 billion in cash and short-term investments as of Dec. 31, the largest end-of-year figure since at least 1991.
S&P 500 companies have approved $149.8 billion in share repurchases in the past three months, exceeding the $125 billion for all of 2009 and the $108.3 billion announced during the first three months of 2010, data from Westport, Connecticut- based Birinyi Associates show.
Companies reducing their shares outstanding are beating the market. The Share BuyBack Achievers Index, which tracks U.S. companies that have repurchased at least 5 percent of their stock in the past 12 months, has climbed 6.3 percent this year, exceeding the S&P 500’s 4.5 percent gain.
ConocoPhillips (COP) has jumped 12 percent since Feb. 11, when the third-largest U.S. oil company boosted its dividend and added $10 billion to its stock buyback plan. The S&P 500 has lost 1.2 percent. Chief Executive Officer Jim Mulva said last week in a meeting with analysts that he plans to increase the Houston-based company’s dividend at least 10 percent each year.
“P/Es are not very high right now, so it’s accretive to earnings per share to buy back shares, and payout ratios are very low by historic standards, so they’re probably going to get those up higher,” Swanson said. “The level of cash coming back to the shareholders is on its way up.”
S&P 500 companies offer a dividend yield, or stock price divided by the annual payment, of 1.84 percent, data tracked by Bloomberg show. That’s below the average of 2.30 percent since 1971. Cisco and WellPoint Inc. (WLP), an Indianapolis-based health insurer, are among the 10 companies in the S&P 500 that said they will start paying dividends this year, according to a March 22 report by S&P. That’s the most for the first quarter since at least 2004.
Cisco of San Jose, California, posted the first weekly gain in more than a month after announcing the payout, which equates to a 1.39 percent yield. WellPoint has jumped 6.2 percent since Feb. 23, when the company said it would begin a 25-cent dividend, compared with the S&P 500’s 0.1 percent drop.
“Having this much cash on the balance sheet earning essentially nothing is hurting companies’ numbers, it’s hurting their return on equity, it’s hurting their ability to provide income in the long run for investors,” said David Kelly, who helps oversee about $445 billion as chief market strategist for JPMorgan Funds in New York. “If they can’t find something better to do with it than leave it as cash, the best thing is to return it to shareholders.”
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