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The Activist-Beleaguered CEO's Survival Guide

Tyler Durden's picture





 

Excess cash on corporate balance sheets has been a hot topic the better part of the last decade, but ConverEx's Nick Colas believes it's about to become even more important to capital markets.  U.S. companies have, after all, regained all the profitability they collectively enjoyed prior to the Financial Crisis.  Moreover, they've accomplished that by rationalizing their business models to succeed in a period of distinctly subpar growth.  Combine that with markets that will likely offer only average returns, and activist investing seems like a worthwhile approach to alpha generation.  Sometimes, however, it pays to look at the world through the eyes of the fox rather than the hounds. As the Einhorn-Cook battle commences, we graciously offer up a few kernels of advice for other companies who get the "Where’s my money at?" call from an activist.

Via ConvergEx's Nick Colas, You Never Give Me Your Money… Only Your Funny Paper

I have a bad habit of rooting for the underdog.  If I happen to turn on a random game that’s already started, I find myself totally invested in the losing team’s cause.  If I see a betting line, I think more about the presumptive loser’s chance of closing the gap, rather than the winning team’s ability to blow out the game.  And yes, this is largely why I don’t gamble.

Moving to issues inside the capital markets, my bias is coming to the fore as I hear more and more about activist investors who want public companies to start using their cash balances in more shareholder-friendly ways.  I do get why these are usually sensible requests.  Cash is a lousy asset – it earns almost nothing and it can easily cause managements to grow lazy since strategic failure isn’t often fatal when there’s 10 years’ worth of cash in the bank.  Shareholders ultimately own the company and its capital.  Yes, there’s that pesky agency problem – management wants the company to be stable enough to endure, but any diversified shareholder couldn’t care less if one company in their portfolio went bust.  But at the end of the day, the shareholder’s desire to earn a competitive rate of return on all their assets should – and usually does – trump everything else.

But what should we say to the fox, rather than the hound?  There are plenty of theoretically valid arguments for higher dividends, special payouts, and stock repurchases for companies with unusually high levels of cash on their balance sheets.  But if you were a Chief Financial Officer, or Chief Executive, or board member, and wanted to push back on these requests – what would you say?  How would you rally investors to your side of the cause, rather than voting with your cash-hungry critics in a proxy fight?

Here are five potential messages for the activist-beleaguered company and its management:

#1 – The country’s central bank doesn’t think we are really out of the crisis – why do you?  Using cash for buybacks and incremental dividends makes sense if the macroeconomic environment is stable and improving.  In a downturn – even a shallow one – cash becomes a critical asset.  Working capital leverage turns negative.  Competitors cut price to clear inventory, and even stronger competitors have to follow.  On the plus side, this is the part of the economic cycle where you can do M&A on the cheap.  Cash is extremely useful for all that.

For the corporate manager going toe-to-toe with an activist on this point, he or she has a strong ally in the U.S. Federal Reserve.  Just read the latest FOMC minutes and you’ll see that their confidence about the continued growth of the domestic economy is muted, at best.  The U.S. central bank still feels that the U.S. economy needs unusually large – unprecedented, really – levels of monetary stimulus.  And this is the environment where you think it would be wise to reallocate our cash?

#2 – That “Extra” cash is to maintain stability among our other stakeholders – primarily our intellectual capital.  The line between intellectual capital (largely in the form of employees) and investment capital (provided by shareholders) is remarkably thin, especially in a technology company.  Yes, shareholders own the company.  But the employees ARE the company.  It’s more of a Mexican standoff than the pyramid structure taught in business schools.

Everything else equal, most people probably – especially a lot of great ones - prefer to work for a company with a large cash balance than a small one.  The former is well-placed to pay a good salary, provide benefits, and grow the business. They can also afford to issue stock and use excess cash to execute buybacks to eliminate dilution.  All good stuff. The less cash rich company?  Not as much.

#3 – We are not alone in our efforts to hold cash – our competitors do it as well.  In one key respect, cash is only a competitive advantage if you have more than your nearest competition.  Consider what happens during an economic downturn – one of the key planning scenarios which cash-rich companies use to defend their outsized liquidity.  If every competitor can cut price to try to hold market share because they all have the same relative cash position, they will all burn through their cash.  Only the company with MORE cash than its peers will be able to leverage that advantage, and only after everyone else has burned through the contents of their piggy banks.

This is a point that is often overlooked in the discussion of appropriate cash balance, but it actually matters quite a bit.  There are case studies galore – just consider why Ford was the only domestic auto OEM to not need bankruptcy protection during the financial crisis – which bring this point home.  At its core, it is a simple but powerful observation: “Yes, we have a lot of cash.  But so does everyone else.  So we need more.  Go away.”

#4 – History shows that cash-activists usually get it wrong in terms of when to ask for the money. At the bottom of an economic cycle there is precious little arguing between shareholders and companies about the appropriate level of corporate cash – no one has any.  Then, as things improve from a macro perspective, the conversations start.  By the time they get to peak earnings, they are at full bore.  That’s pretty much where we are now, but it is the worst time to pull capital out of companies.  If they do a stock buyback, it’s likely to be at the peak.  If the company chooses to pay an ongoing dividend, they’ll likely set it too high.  As for a special dividend, anyone receiving it will likely reinvest it in other equities. Also at a cyclical peak.

#5 – If you like it so much, bid for the whole company.  At the end of the day, there is really only one way to create lasting change in the financial strategy of a public company – buy it.  All of it.  This is not as easy as it was in prior cycles.  Mammoth bank or public debt market – funded leveraged buyouts aren’t yet back in vogue.  And given the fragility of the financial system, they may not make an appearance during this particular cycle.  And without that threat, the role of the activist is much more that of an unpaid investment banker – offering up ideas in the hopes of getting paid – than anything else. 

 


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Fri, 02/08/2013 - 20:38 | Link to Comment disabledvet
disabledvet's picture

Apple is an "activist beleagured company"? Sure...Tim Cook took the call. Now what? "You want to start offering up advice on better phone design"? Oh, I see..."my money is more important than yours." I get it!

Fri, 02/08/2013 - 20:40 | Link to Comment Say What Again
Say What Again's picture

#6  The extra cash is reserved to pay for hookers and lawyers.  You know we'll need both in these tough times.

Fri, 02/08/2013 - 20:49 | Link to Comment trav777
trav777's picture

they should disgorge the cash so us equity holders can get dividends.

That's the mechanism the system should use to get that Fed money out into the economy.  TRICKLE DOWN baby lol

Sat, 02/09/2013 - 07:16 | Link to Comment zhandax
zhandax's picture

Trav, I am not sure most people realize how profound a statement you just made.  Huge multinational corporations are the cancer in this economy.  Ever hear 'corporatoracy' in these pages?  Shareholders need to loot them dry of cash, and see just how 'talented' the MBA team is in the lean, mean, new century.  If the shareholders bleed them out of existence it will be a blessing, but the truly superior MBA squads should be able to innovate their way around that.  Otherwise, wait and see if the fed can keep ahead of BOJ on currency devaluation, and what that does to that cash balance.

Fri, 02/08/2013 - 20:55 | Link to Comment bobthehorse
bobthehorse's picture

Companies love cheap labor.

So they keep their money on the sidelines.

Why waste it on American?

The Chinese will do the work for a fraction of the cost.

http://www.angrysinner.blogspot.kr/2013/02/saturday.html

Fri, 02/08/2013 - 21:53 | Link to Comment Rusty Shorts
Fri, 02/08/2013 - 20:44 | Link to Comment davidsmith
davidsmith's picture

In a downturn – even a shallow one – cash becomes a critical asset.  Working capital leverage turns negative.  Competitors cut price to clear inventory, and even stronger competitors have to follow.  On the plus side, this is the part of the economic cycle where you can do M&A on the cheap.  Cash is extremely useful for all that.

 

 

 

But that's not the activist argument.  The activists are not arguing that a "downturn" is ahead.  They are arguing that a DISASTER is ahead.

Sat, 02/09/2013 - 10:14 | Link to Comment CPL
CPL's picture

Weird how the adjective has changed in five years non?

Fri, 02/08/2013 - 20:45 | Link to Comment davidsmith
davidsmith's picture

By the way, looks like Schmidt agrees that a disaster, and not a "downturn," is directly ahead of us:

 

SAN FRANCISCO (MarketWatch) -- Google Inc. GOOG +1.48% chairman Eric Schmidt plans to sell up to $2.51 billion of his share in the company, according to a Securities and Exchange Commission filing late Friday. Schmidt owns 2.3% of Google's outstanding shares and has 8.2% of the voting power. Under the plan, Schmidt, who owns about 7.6 million shares of Google stock, plans to sell about 3.2 million shares of his Class A stock. 

Fri, 02/08/2013 - 20:45 | Link to Comment davidsmith
davidsmith's picture

By the way, a DISASTER is directly ahead of us.

Fri, 02/08/2013 - 20:46 | Link to Comment zerozulu
zerozulu's picture

Dollar may get devalued soon, that's what aapl investor are sweating about aapl balance sheet full of cash.

Fri, 02/08/2013 - 21:05 | Link to Comment Say What Again
Say What Again's picture

Hmmm...  Didn't we already learn that a majority of CRAPPL CASH is in foreign currencies?

How would a weakening dollar affect affect them

Fri, 02/08/2013 - 22:36 | Link to Comment NoDebt
NoDebt's picture

The Dollar is far from the only currency being devalued.  You can't geographically diversify your fiat stockpiles around what's happening now.

I'm sure some of APPL's funds were in Japanese Yen.  How do you think those funds were affected in the last couple months?

Fri, 02/08/2013 - 21:38 | Link to Comment Black Markets
Black Markets's picture

The cash is there to deter competition.

It's like Microsoft in the 90's, they too built a mountain of cash to signal to the world that if anyone makes a serious attempt to compete with them they have a $40bn war chest to crush you like an ant and you will lose all your money. So don't bother.

And nobody did. For over a decade.

Sadly AAPL are under siege from Samsung,who just don't care about the threat of Apple monetizing their war chest to fight them. Samsung have figured out that Apple was a personality cult and Apple don't have the development capacity to put their cash into action.

Fri, 02/08/2013 - 21:54 | Link to Comment adr
adr's picture

HAAA HAA HA, excess cash. It doesn't exist. It is a mark to fantasy balance sheet adjustment that exists on paper only. Like the 1990s budget surplus under Clinton. Look we changed the definition of how we counted our money and voila, SURPLUS!!!!!

If there is extra cash on the books my buyers sure haven't seen it. The only thing they talk about is how bad corporate cash flow is right now. If there was so much extra cash, wouldn't we see better CapEx numbers?

It is amazing how under mark to market rules there was no cash, they suspend mark to market accounting and within months corporations had immense stockpiles of cash. You want to tell me that between March 2009 and June of 2009 a corporation like Select Comfort really moved a couple hundred million in inventory. Of course changing the rules on how inventory was counted had nothing to do with it. Dead inventory counted as an asset instead of a liability.

Record corporate cash is nothing but a record corporate scam.

I could make myself look very wealthy if I could count my debts as assets and then leverage them 100:1 to take out loans. Using my home as a $130k asset instead of a $130 debt, and using it as collateral for a 100:1 leveraged loan could get me over ten million dollars. Fuck then I could invest that $100 million in NFLX, preferably the day before earnings so I could ride the 80%+ single day gain. Boom $80 million profit. I pay off the loan, pay the 20% capital gains tax, retire and never work again.

I'm a multimillionaire and I never actually had any money in the first place. WHAT A WONDERFUL SYSTEM. No wonder that 16 year old skank decided to invest.

Fri, 02/08/2013 - 23:29 | Link to Comment francis_sawyer
francis_sawyer's picture

 "You want to tell me that between March 2009 and June of 2009 a corporation like Select Comfort really moved a couple hundred million in inventory"

~~~

Yeah ~ Everyone started stuffing their mattresses with cash & needed a bigger one...

Fri, 02/08/2013 - 23:14 | Link to Comment ekm
ekm's picture

Quite impressive.

Fri, 02/08/2013 - 23:08 | Link to Comment Clowns on Acid
Clowns on Acid's picture

So is Convergex calling for a downturn in the market, surreptiously? Because if there uis "a downturn" whats the Fed going to do....besides print more?

And the the timing of higher tax rates couldn't have been better.

They better be careful....ask Egan Jones and S&P. 

Fri, 02/08/2013 - 23:10 | Link to Comment masaccio
masaccio's picture

Or, the poor beleaguered titans could fill a pool with light bulbs and dive in.

Sat, 02/09/2013 - 04:01 | Link to Comment dunce
dunce's picture

Cash is not a real problem, debt is a problem. In  a business down turn a company must be able to service the debt, when there are no profits then the debt can be serviced by cash reserves. I do not know how a company with no debt can find itself in bankruptcy. Paying down debt might be the best thing for some companies, for others cheap debt is hard to resist if it can be deployed to increase production. There is a business cycle , so it is not a question of if, but when revenues drop.

Sat, 02/09/2013 - 06:00 | Link to Comment Catullus
Catullus's picture

Yeah, these are cool theoretical responses that hold water for one earnings call. 

If this is peak earnings and there's still a crisis going on and competitors are ready to storm the gates, then I need to re-evaluate my multiples on earnings.  Those are really good reasons to think that a 12 P/E is rich. 

Sat, 02/09/2013 - 10:03 | Link to Comment U4 eee aaa
U4 eee aaa's picture

What are you talking about? That cash is vital. It is needed to boost the stock at the time the CEOs options come due

Sat, 02/09/2013 - 12:54 | Link to Comment Frastric
Frastric's picture

How much purchasing power has this cash lost over the last twenty years? All these MSM analysts claim there's 2 trillion in cash just waiting to be deployed, but we know that inflation has been underreported so if it's 5% and over twenty years a lot of purchasing power has been lost. But MSM just can't seem to grasp purchasing power and instead ALWAYS focuses on the nominal value of cash, stocks, bonds, whatever...

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