VideoFrom 1995 to 2002, Terex Corp. was a terror on the mergers-and-acquisitions scene, snapping up a string of 22 takeover targets. Since then, the Westport, Connecticut-based manufacturer of construction and mining equipment has kept its checkbook much closer to the vest, as cash-rich private-equity buyers drove prices beyond where it felt it could make disciplined acquisitions. No matter: the $8.2 billion company still managed to grow its revenues by an average of 28.8 percent each year. Shareholders responded by driving up Terex's stock price from less than $6 at the beginning of 2003 to more than $80 in late September.
Thanks to its stellar performance, Terex ranks sixth among the companies in the Standard & Poor's 500 stock index (excluding financial institutions) in terms of total shareholder return (TSR) over the past five years. That's according to a new analysis done for CFO by The Boston Consulting Group (BCG). At 49 percent, Terex's five-year TSR is well above the average for the top quartile of the S&P 500 (see "The Value Creators").
Accordingly, Terex has had the luxury of piling up cash on an underleveraged balance sheet — $453 million as of June 30 — at a time when investors are pushing many companies to make big payouts to shareholders. The company did launch a $200 million stock-buyback program last year, but against a market capitalization of $9.3 billion that's not terribly aggressive.
Terex could buy back more stock, or issue a special dividend. But it is committed to reinvesting in its business for long-term growth, according to Terex senior vice president and CFO Phillip Widman. "We consider our first priority to grow the business we have, meaning through investment in capex or acquisitions that help further our franchise," he says. "We have a return on invested capital of 40 percent the way we measure it, so investing in our own business makes sense right now."
Building for long-term growth is, of course, what business schools have been preaching for generations. But it has been surprisingly difficult to do so over the past several years, says Eric Olsen, senior partner in the Chicago office of BCG, a global business-consulting firm. What was once viewed as a strong balance sheet, BCG says, is increasingly viewed by Wall Street as a lazy balance sheet — one that underexploits a company's assets, either by holding too much cash earning low rates of return or by having too little debt. (Olsen says the credit crunch hasn't changed that perception, except perhaps in sectors directly affected by the crunch, such as mortgage lending.)
Today, firms with bulging cash coffers risk being penalized rather than praised. And the cash has been piling up. Thanks to strong balance sheets and improved cash flow return on investment, corporate profits have soared to record levels, notes BCG. What's more, given the recent upheaval in the credit markets and the growing fear of an economic slowdown, companies may not be inclined to draw down their cash reserves anytime soon.
In this environment, investors either hold back on giving a cash-rich company's stock its full due or push for a way to get that money into their own pockets, typically through a stock buyback. If management won't pull the trigger, private-equity firms and activist investors are happy to do the job. The challenge, then, is for companies to satisfy their investors' short-term expectations while retaining enough resources to execute long-term strategy — without stumbling into what BCG calls a "cash trap" (see "Avoiding Cash Traps" at the end of this article).
Opportunity Costs
Ironically, the easy money of the past few years, a byproduct of rising corporate profits and stock prices, is in some ways limiting the options available to corporate managers. In too many industries, it has allowed for too much cash chasing too many growth opportunities. "There are private-equity deals getting done in industries that never would have been candidates for private equity in the past, at pricing that probably wouldn't have made sense in the past," observes J.D. Sherman, CFO of Akamai Technologies Inc., a $429 million Internet services firm in Cambridge, Massachusetts.
Still, it's not surprising that companies are trying to do something with their cash. Assuming aftertax returns on cash of 3 to 4 percent, and market-average returns of 10 percent on a stock index fund, the forgone opportunity cost for investors is 6 to 7 percent. "That opportunity cost," writes BCG in "Value Creators," "has a negative impact on annual TSR of one to two percentage points, on average, which over 10 years is equivalent to the difference between top-quartile and average performance."
Many companies have, of course, turned to stock buybacks. Through the end of last year, companies in the S&P 500 had bought back more than $100 billion in shares in each of the past five quarters, nearly double what they were paying out in dividends. There's some logic to that, says BCG, given that many companies are carrying cash and excess debt capacity equal to 20 to 30 percent of their market capitalization. Still, BCG argues that buying back stock doesn't deliver much in the way of long-term value, meaning that corporate executives must still find ways to differentiate their companies from their competitors and demonstrate that they can deliver profitable, above-average growth.
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