VideoSee the 2004 Cash Management tables
Having fortified their balance sheets with cash over the past two years, one would think that CFOs would have little to worry about from investors.
At the end of 2003, cash and marketable securities constituted roughly 15 percent of the total capital employed by 1,000 companies tracked by REL Consultancy Group. That's up from 11 percent two years earlier. In terms of sales, the proportion grew from 8.5 percent to 11.5 percent. And despite a recent spate of investments and acquisitions, there's little sign that those percentages have come down significantly since then.
But equity investors have other ideas about holding so much cash. They prefer to see the money earning more than it can in bank accounts or short-term instruments. That preference often translates into pressure to buy back shares, pay dividends, or increase existing payouts if managers can't identify promising prospects for acquisitions or new capital investments.
Bondholders, on the other hand, would rather see companies maintain plenty of cash to cover their interest burdens. As for ambitious acquisitions or capital investments, fixed-income investors burned by highly leveraged undertakings during the 1990s bull market are unlikely to sit still for risky alternatives this time around — however much equity investors may clamor for them.
Ideally, all companies would keep little or no cash on hand. Yet that's not always feasible for those that have borrowed heavily, particularly in industries pounded by recession. And while finance theory offers neat formulas for choosing among different uses of cash, those formulas aren't easy to apply when economic prospects are uncertain.
That leaves CFOs of cash-rich companies caught in the middle. "Corporate cash balances have never been higher," Rizwan Hussain, an analyst for Morgan Stanley, told the annual conference of the Bond Market Association last spring. "But what are companies going to do with them?"
REL, a Purchase, New York-based consultancy that helps companies improve working-capital management, comes down squarely on one side of the issue: get rid of the excess cash. "In our view, companies are going from one extreme to another in terms of their risk assessment," says principal Bill Beech. "Most have become overly cautious." REL has helped CFO magazine develop a scorecard ranking companies within their industries on how effectively they're managing cash.
Corporate finance executives agree to some extent. "Cash is really an underperforming asset," says Elisha Finney, vice president of finance and CFO of Varian Medical Systems, a maker of medical radiation and imaging technology based in Palo Alto, California. Varian, which had revenues of $1.04 billion last year, saw its cash as a percentage of sales hit 31 percent at the end of 2003 — almost three times its industry average, according to REL. "But it's a good problem to have," maintains Finney. "We say, 'Cash is queen.' "
Finney is not alone in expressing that view. "We're carrying slightly more cash than we historically carried," says Robert Richter, CFO of Dana Corp., an auto-parts supplier whose cash grew from 1.9 percent of sales in 2001 to 9.2 percent last year, three times the industry average. While he notes that that number was inflated by the maturation of some $200 million in long-term debt and an increase in working capital, Richter says Dana has needed to keep cash levels higher since the company lost its investment-grade rating in December 2001. "It serves one well to have a little more cash on hand when one's ratings are under stress," he says.
As Finney puts it, "I would rather have too much cash than be highly leveraged any day."
Comforting Cushion
Truth be told, the dramatic efforts undertaken in the past few years to improve balance sheets, whether through asset disposals or debt reduction, have created a comforting cushion at present for bondholders. As of March 31, the 374 industrial companies in the Standard & Poor's 500 stock index collectively had $555.6 billion in cash and short-term investments on their balance sheets. That's up some $56 billion, or 11 percent, since the end of 2003, and more than double what they had at the end of 1999.
How does that compare with debt levels? The top 100 investment-grade issuers at the end of 2003 collectively had cash on hand equal to 20 percent of their debt, up from 11 percent in 2000 (see "The Dough Rises," at the end of this article). Hussain says investors in high-grade corporate bonds are unlikely to grow nervous until that percentage falls back to 14 or 15 percent. He expects that cushion to shrink to such a level within a year or so.
Some companies have so much cash that they don't know what to do with it. Sears, Roebuck and Co., for instance, has bought back more than 40 percent of its shares outstanding since 1999. And in June, it announced it would pay $621 million in cash for 54 stores from bankrupt Kmart Corp. Yet the troubled retailer is still awash in cash. With its retailing business lagging, Sears's huge cash hoard makes it a likely candidate for a buyout, according to Hussain.
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