Corporate Finance

Watchful Waiting

With a less-clear, less-robust future ahead, CFOs get more careful about how they spend corporate cash.
Lauren MuskettDecember 12, 2019
Watchful Waiting

Amid growing fears of economic turmoil, pessimism appears to have crept into the perspectives of some finance executives. More than half (53%) of 225 U.S. CFOs surveyed by Duke University and CFO Research in the third quarter believe that the nation will be in a recession by the third quarter of 2020.

More tellingly, the percentage of CFOs who say they are more optimistic about the state of the U.S. economy dropped to 12%, down from 20% in June and 44% a year earlier. The number of CFOs who say they are less optimistic climbed. 

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“Winter is coming,” says John Toth, the CFO of Bark, a private-equity-owned firm that provides subscribers with monthly packages of dog treats and toys. “It’s a question of when, not if.”

For his small, privately held company, memories of 2008’s liquidity drought have tempered cash-allocation plans. “We’re certainly not spending down our cash reserves,” he says. “We are organizing our P&L to make sure that we can be self-sufficient.”

Toth came to his decision after speaking with venture capitalists and private equity investors who, he says, are preparing for the worst. “My perception is that [investors] are building their war chests not necessarily to go to war but to outlast what is generally perceived as a slow period coming,” he says.

Despite Toth’s “Game of Thrones”-type sentiments, many companies aren’t ready to run for the exits. In the spectrum that stretches from hoarding cash to keeping it level to spending it down, few companies seem focused on socking away large quantities of the green stuff. Still, some are building up liquidity and keeping their hands off cash reserves — just in case.

Growth as a Shield

Payment services company Wex and enterprise security vendor Proofpoint are examples of companies accumulating cash, but for growth initiatives: their CFOs see continued revenue boosts as a way to protect the balance sheet. Operating in an expanding economy, they worry much more about missing opportunities than going belly-up. 

Roberto Simon, a former Revlon CFO and now finance chief of Wex, knows a lot about how cash priorities can differ among companies. In the slow-growing consumer goods market, Revlon focused on reducing waste and increasing profit margins. In contrast, Wex been on a growth tear in the four years since Simon joined, nearly doubling its revenue to a projected $1.7 billion in 2019.

Acquisitions have driven much of that increase. In the third quarter of this year alone the company added $42 million of revenue via the acquisitions of Noventis, Discovery Benefits, and Go Fuel Card. Because of Wex’s deal appetite, one of its top priorities is having enough liquidity to pounce on opportune targets when they hit the market. Thus, the possibility of a recession represents a threat to the liquidity available to fund growth through acquisitions. 

Wex has $531 million in cash and cash equivalents. Its approach to buttressing liquidity involves locking in credit agreements at favorable terms and at longer maturities, Simon says.

In a five-year deal with its banks inked in 2018, Wex boosted its revolver to $720 million from $570 million and hiked its term loans by $25 million. The financing lets Wex continue pursuing acquisitions amid the uncertainties of events like the U.S.-China trade war and the 2020 presidential election—without touching the cash it might need if a severe downturn hits. 

Force Multiplier

At Proofpoint as well, the focus is “to just keep going full bore” on its merger-fueled strategy of aggressive growth, says Paul Auvil, CFO. Proofpoint has bought 10 companies since 2015.

Last year’s high valuations, however, kept Proofpoint out of the deals market. “We were at this pinnacle of valuation expectation on the part of smaller private companies,” Auvil says. “All they had to do was deliver some revenue growth, no matter how poorly they managed the rest of the business, and people had just wild expectations of what that price would be.”

As a result, Proofpoint had a “long quiet period” of very little M&A activity. “Those valuation expectations just didn’t match what we felt we could reasonably pay,” Auvil said. 

More recently, expectations may have come down to earth. In early November, Proofpoint bought ObserveIT, an insider-threat intelligence firm, for $225 million in cash. In the absence of a recession, Auvil says, he hopes he sees a “maturing in the perspective of these smaller companies” that will help Proofpoint continue its acquisitive ways.

“But if we can’t find the right asset at the right price, then we’ll just stand down and leave the cash earning interest in the bank,” he adds.

Proofpoint is not taking any chances that the cash won’t be there for future deals. In August, the company announced a $750 million senior-note offering due in 2024. Says Auvil: “What that enables us to do is have this significant additional cash balance, not as a buffer against the potential economic downturn, but more as a force multiplier.”

At Profit’s Expense?

Even with lagging growth, many subscription-model tech companies aren’t particularly worried about profit. For such companies and their investors, the non-GAAP metric of free cash flow is replacing GAAP earnings as the “gold standard” of financial health, according to Manoj Shroff, managing director of finance and accounting services at Accenture Operations. 

Indeed, to listen to these companies and to their investors, these beneficiaries of the “technology supercycle” seem to be in a world of their own. Jennifer Ceran, the finance chief of publicly held Smartsheet, a cloud-based business-planning platform, deploys a benchmark called the “40% rule”: a healthy company’s growth rates for revenue and profit should add up to at least 40%. 

“So, if you are growing at 20%, you should be generating a profit of 20%,” Brad Feld, a prominent tech analyst, has written on his blog. “If you are growing at 40%, you should be generating a 0% profit. If you are growing at 50%, you can lose 10%. If you are doing better than the 40% rule, that’s awesome.”

Employing free cash flow as her profit metric, Ceran says she would be “very comfortable to record negative free cash flow of 10%” for a quarter if the company’s revenue growth came in at 70% or 80%. In that case, she would be encouraged to “lean in” on the company’s quest for soaring sales. 

Still, Smartsheet can’t be too lackadaisical about what’s over the economic horizon. CFO Ceran, who has held senior finance and treasury posts at companies like Cisco and Sara Lee, acknowledges that companies must retain a “rainy day fund that every CFO needs for unintended outcomes.” (Smartsheet’s is $561 million.) She adds: “We definitely won’t go to zero. I can tell you that.”

Disappearing Cash

That wouldn’t be a wise move for any company, because things may be more cash-precarious for industries with substantial fixed assets and heavy expense lines, like automobiles. In those sectors, revenues — and the cash flows they support — have been drifting downward, according to Charles Mulford, an accounting professor at Georgia Tech and the head of the university’s financial analysis lab.

In the first quarter of 2019, median revenues among the 2,600 nonfinancial companies that Mulford tracks were $1.23 billion, down from $1.25 billion in December 2018. It was the fourth straight quarterly decline since the record high established in the fourth quarter of 2017. 

“What drives corporate cash balances is revenue,” says Mulford. “With declining revenue, we’re seeing that companies’ ability to generate free cash flow is also declining.” (Mulford’s lab defines free cash flow as the cash flow available for common shareholders that can be used for such discretionary purposes as stock buybacks and dividends without affecting the firm’s ability to grow and generate more.)

Further, working capital performance has been degrading, notes Mulford. Accounts receivables are growing and more capital is being tied up in inventory. These factors are slowing down the time it takes for companies to convert their outlays into cash.


Slow-growing revenue is undoubtedly causing many industrial companies to look more closely at cash allocations and spending. Capital expenditures, for one, help drive the economy. After an increase in capex spurred by the 2017 Tax Cuts and Jobs Act, for example, spending has been dropping for much of 2019, according to the Georgia Tech Financial Analysis Lab.

At first, the new tax law seemed to be achieving its desired end of triggering business investment. Following three quarters of falling corporate outlays for plant, equipment, and the like, median capex as a percentage of revenue rose in the four quarters ending December 2018.

But in the first quarter of 2019, capex as a percentage of revenue declined to 3.64%, down from 3.79% the previous quarter. Third-quarter earnings data showed that while capex spending grew 3.2%, fourth-quarter projections were lower: 1.8%, according to Refinitiv.

“What really is frustrating is that although lower tax rates could have helped generate capital expenditure, the bad talk about tariffs just killed the animal spirits,” says Mulford.

Stephen Foley, head of U.S. corporate banking at T.D. Bank, says he has seen a dampening of enthusiasm for capex among his clients. 

“A lot of people I’ve talked to say they’re a little hesitant about investing in capex because the payoff isn’t so quick and defined as other cash investments.” To them, it’s “investing in capacity that you might not need down the road.”

To allocate a significant amount of cash to capex today implies confidence in “the hope of growth tomorrow,” adds Bark CFO Toth. “I would rather have the cash, because it’s a less clear, less robust future” today. 

Like capex, M&A activity, at least for some, seems primed for a downgrade on the list of corporate cash priorities. “We’re 10 years into a recovery cycle, and valuations are near all-time highs,” says Foley. 

Considering the cloudy economic picture, substantial acquisitions are “the kinds of bets that companies just don’t feel like taking right now.” 

While the number of U.S. deals rose 19% in October, for example, total deal value fell 30%, to $106 billion, according to investment bank Baird.

Large companies, indeed, are taking the other side of transactions — divesting assets to improve liquidity.

When AT&T agreed to offload its wireless operations in Puerto Rico and the U.S. Virgin Islands for nearly $2 billion in cash in October 2019, it was responding to its own recent history: the after-effects of a $200 billion merger spree culminating in 2018’s $109 billion acquisition of Time Warner. 

Referring to the asset sales, AT&T CFO John Stephens said that the deal was “a result of our ongoing strategic review of our balance sheet and assets to identify opportunities for monetization.”

The sale was also part of a cash-allocation agenda being pushed by activist investor Elliott Management. Harshly critical of what it sees as a huge undervaluation of the telecom’s sales, Elliott Management is pushing AT&T to halt significant M&A activity and tighten its operations to generate enough cash to pay down its huge debt. It also wants the cash to fund a steady stream of share buybacks. (See “Pulling Back on Buybacks” below.)

Staying Put

Although the U.S. economy has not technically entered a recession, Mulford says that the declines in revenue and cash flow “are things that start to give you the early indications of that.” In November, the Atlanta Federal Reserve Bank’s GDPNow model was projecting U.S. GDP growth of only 0.4% in the fourth quarter.

A company’s business model can be partial insurance against a downturn, or at least that’s what some finance chiefs believe. Proofpoint’s Auvil says the company has a built-in buffer against cash shortfalls: almost all of its business is subscription-based. 

With checks from its corporate subscribers pouring in each year, the company generates substantial cash flows. At the end of the third quarter, the company reported $1.05 billion in cash and cash equivalents.

“In an economic downturn, even if our growth rate slows a little bit we still generate a lot of cash,” he says. “So, we won’t have a situation where if the economy slows, our top-line business could suddenly collapse and create a liquidity crisis for the company.”

Clearly, some companies are still riding the tailwind of economic growth. And why not? There’s still ample cash in the U.S. economy—about 10% higher than the norm, in part due to high leverage. Some CFOs, therefore, don’t feel the urgency to go into hibernation mode and stash more of it away. 

Still, says Mulford, “I would be inclined to think that managers will tend to stay where they are.”

Freelancer David M. Katz is the former New York bureau chief of CFO.