Ever heard of a "lazy" balance sheet?
It was a new turn of phrase for me when Inco chief executive officer Scott Hand threw it out last week. Mr. Hand was explaining just how he arrived at the financial formula for buying Falconbridge, a deal that will see Inco do the biggest mining takeover in Canadian history with up to $2.87-billion in cash and 201 million of its own shares.
The idea here is to offer investors who want cash as much of that commodity as possible, without saddling Inco with stupid amounts of debt, while also offering a tax-free move into the merged companies for those who take paper. When he talked about the fact that Inco must borrow to pay that $2.87-billion, Mr. Hand said he was quite comfortable going into hock, as the company anticipated retaining an investment-grade credit rating, and paying down all this new debt within two years. That's when he added: "We don't want to be accused of having a lazy balance sheet."
The concept was new, but I understood exactly what Mr. Hand meant. Inco's CEO isn't worried about having too much debt. He's worried about not borrowing enough.
Welcome to the new paradigm in Corporate Canada.
The majority of our companies are awash in cash. Courtesy of low interest rates, easy access to equity, the red-hot commodity cycle and a strong economy, we've got balance sheets in better shape than they've been at any time since the 1970s. (Various Canadian governments are also experiencing this same giddy prosperity, with the federal folks seemingly intent on spending, while the Alberta crowd takes a view that they should give it back to citizens.)
The challenge facing CEOs is what to do with this good fortune, how to best seize the day on behalf of shareholders. And it's actually no easy task.
For CEOs like Mr. Hand, being flush with cash and enjoying a strong stock valuation means chasing straightforward strategic goals. The Falconbridge takeover has beckoned for decades, and the stars have lined up for Inco to do the deal. (The only problem is soaring metal prices mean most global mining companies also now have the deep pockets needed to take a run at Falconbridge, or even Inco itself.)
In most other cases, the path ahead isn't as clear.
Consider the banks. Until it stepped on an Enron landmine, Canadian Imperial Bank of Commerce embraced the income trust approach to extra cash. The bank bought back shares, hiked the dividend, and refused to wheel and deal.
The CEOs at Toronto-Dominion Bank and Bank of Montreal, on the other hand, decided not to switch to a cruise control strategy. They made a case for shareholders being better served by a U.S. expansion.
Taking it one step further, the great guessing game in Canadian banking is figuring out just what the newly named CEO of Bank of Nova Scotia will do with the biggest pile of excess capital in the sector -- Rick Waugh is blessed or burdened with $5-billion more than he needs to run the place. If that capital ends up being poorly deployed, Scotiabank loses its premium stock multiple.
The question of what to do with surplus capital also underpins the income trust debate. Fans of the sector see handing out distributions as a fine form of discipline on management. Detractors fear trusts breed caretaker CEOs who have no incentive for reinvestment in the business in vital areas such as research and development. The capital markets hang in the balance as this argument plays out in Ottawa.
There's also table-thumping taking place over what to do when times are good in battle-scarred sectors such as steel and the airlines.
Companies such as Algoma Steel and Transat A.T., which are flush but no strangers to tough times, are struggling with their current bouts of good fortune. In the case of Algoma, there's now a very public difference of opinion between the company's hedge fund owners, who want more than $400-million flushed out to shareholders, and a board of directors that wants to save for a rainy day.
Step back from the specifics, and it's clear we're going to need a new approach to evaluating CEOs. After watching a generation of executives (and politicians) be judged in part on how they dealt with debts, a common yardstick going forward will be how CEOs such as Mr. Hand meet the challenge of spending their excess capital.
Prosperity holds promise, but there are going to be CEOs who are punished for having lazy balance sheets.
Andrew Willis