Everyone knows that companies worldwide are sitting on cash, generating cash, and have the capacity to borrow yet more. But where will it go? The optimistic answer would be into the real economy. The reality is probably into M&A and buybacks.
Apple’s $98-billion (U.S.) pile is emblematic of a growing corporate cash mountain. As of December, the 1,100 non-financial U.S. corporations rated by Moody’s were sitting on record gross cash balances of $1.24-trillion. The credit rating agency’s 360-strong universe of generally larger-cap European non-financial corporates had $872-billion of gross cash at June 2011, just shy of the 2010 record.
At the same time, gearing – net debt to equity – is modest. For European companies it is now at about 30 per cent, a state of affairs not seen since the 1980s, according to Morgan Stanley. About one-third of Europe’s corporates are debt-free.
It’s not hard to see how this happened. Companies went into the crisis with relatively low leverage. When the banking sector froze, they cut borrowing further. Meanwhile, the downturn provided cover to slash operating costs and capital expenditures. With demand propped up by economic stimulus, record profit margins have followed. To cap it all, repressive monetary policy has squashed long-term interest rates, pushing yield-hungry investors into corporate bonds.
The upshot is that record profitability is not feeding into higher returns on equity, according to Barclays Capital. Even if memories of the crisis prompt companies to keep permanently bigger cash buffers, that’s not a situation that management or investors are likely to tolerate for long.
In the United States, cross-border M&A looks the most likely response, given that most corporate cash is held overseas and would be taxable on repatriation. For companies with commodity-based costs, cost-crunching deals are a solution to an expense line that’s going up as revenues flat line. In Europe, risk-aversion caused by recent shareholder hostility to M&A makes buybacks more likely.
The other option is investment, though poor economic visibility will regrettably prove a deterrent. Companies may also be setting overly high return hurdles for a financially repressed world. More buybacks, less investment. This de-equitization comeback is good for the equity market, Barcap suggests. But it’s probably not what central bankers had in mind as they slashed rates and flooded the economy with liquidity.