Roy also suggests that managers may be more cautious about how they deploy their cash because the penalty for messing up has gotten stiffer. "Managements are much more aware that the [career] life of the executive, if he or she doesn't perform, has gotten a lot shorter," he says. Exhibit A: former Hewlett-Packard CEO Carly Fiorina, who was unceremoniously dumped from her post at the $79.9 billion computer and printer maker early this year, in part due to lingering discontent with the 2002 purchase of Compaq Computer. HP is still trying to digest that acquisition.
Moody's itself dramatically built up its cash levels from 2002 to 2004, with its cash-to-sales ratio jumping to 42.1 percent from 3.9 percent. That put Moody's well above the 2004 year-end average of 11.0 percent for the companies in the industrial and commercial-services sector in which it competes. According to Roy, the increase was attributable primarily to Moody's being less aggressive than it typically has been about using its ample free cash flow to buy back its own shares. "We return quite a bit [of cash] through share repurchases," he says. "In the past couple of years, though, we have not been as aggressive about our buybacks."
Of course, Moody's has not had much of an opportunity. From January 2003 to the end of July 2005, its stock rose from just under $22 a share to more than $47 in virtually a straight line. Still, Roy says the company plans to become more "systematic" in its approach to buybacks, suggesting that going forward, it won't wait for a decline in price to repurchase more shares.
Looking for Bargains
The fact that Moody's had cash on hand to even consider buying back stock indicates that it wasn't having much luck finding external investments at good prices. It has been hardly alone in that situation; from year-end 2002 to year-end 2004, the Standard & Poor's 500 stock index rose 37.9 percent. Yet the stock of an acquirer no longer represents as valuable a currency as it did when pooling-of-interest accounting was easily available, so higher prices make acquisitions more expensive. That's held back such companies as West Greenwich, Rhode Island–based Gtech Holdings Corp., a $1.3 billion provider of lottery and gaming technology solutions. "Public-company valuations are fairly high in the industries we're looking at for acquisition opportunities," says Gtech CFO Jaymin Patel. The company saw its cash-to-sales ratio jump to 33.4 percent from 3.6 percent over the two years ended February 28, 2004 (Gtech's fiscal year-end). "As a fairly conservatively run business, we're simply not prepared to pay up at the kinds of market values these assets are commanding," says Patel. "We're a patient company, and we're prepared to wait if necessary."
And despite strong cash flows in recent years, Gtech has seen fit to borrow to bolster its reserves. The firm sold $250 million in senior notes in October 2003 and another $300 million in 2004, taking advantage of what it considered attractive long-term rates for investment-grade debt. Although it is conserving some of that firepower for future acquisitions, last December the firm announced an agreement to purchase a 50 percent controlling equity interest in Atronic, the leading video-slot-machine maker in Europe, Russia, and Latin America. However, that deal will not close until December 2006.
Phoenix-based regional airline operator Mesa Air Group Inc. also built up its cash reserves over the past two years by way of debt offerings — two convertible-bond issues of $100 million each — but not necessarily to fund future acquisitions. "This is a very capital-intensive industry, and capital is not always readily available," observes CFO George Murnane. "Just when you need it is probably when you don't have access to it. We felt very strongly that given the turmoil in our industry, we needed to have more liquidity." By year-end 2004, Mesa's cash-to-sales ratio stood at 26.6 percent, more than double its level of 10.9 percent two years earlier and well above the industry average, which rose to 17.8 percent from 17.6 percent during the same time period. "For an airline," says Murnane, "more cash is better than less."
That point has been driven home over the past five years. Murnane notes that the airline business was already starting to soften when terrorists attacked the United States on September 11, 2001, exacerbating the industry's problems and helping to drive two of Mesa's partner airlines into Chapter 11 bankruptcy protection. But thus far, he says, Mesa has been able to operate without tapping into its recently plumped cash stockpile, leaving it open to the possibility of making an acquisition should a good opportunity present itself. In the meantime, he says Mesa's cash position is expected to continue to swell. "We have said publicly that at the end of our fiscal year (September 30), we expect our cash levels to be about $275 million [versus $221 million at the end of fiscal 2004], and we are exploring some other liquidity-generating measures that would get our cash levels to $300 million," he says. Since then, Mesa has monetized its regional jet spare-parts inventory by allowing a third party to purchase and manage it on its behalf.
If the trends of the past two years continue, corporate cash-to-sales ratios will continue to grow in 2005, though at a slower pace. That would make perfect sense to all those finance executives who agree that absent extenuating circumstances such as the need to fund an acquisition or carry the company through a business downturn, holding excess cash is a drag on performance. Too bad those circumstances are so hard to predict.
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