Corporations spend cash reserves to buy competitors and favor shareholders

Since the beginning of 2011, the number of mergers and acquisitions has increased sharply, with companies increasingly financing all or part of the deal in cash. The largest American companies alone have accumulated approximately $1 trillion in cash. Those who, after the end of the acute phase of the crisis, were able to accumulate significant amounts of cash, are now using them to take over competitors, and also pay dividends to shareholders in an attempt to gain their favor.

Looking for a target to absorb

Globally, $717 billion in mergers and acquisitions were announced in the first quarter, up 58% from a year ago, according to Thomson Reuters. Moreover, almost half of the M&A - $352 billion - was carried out with the participation of American companies. This was the largest quarterly figure for US M&A since the second quarter of 2008. Last week, Ernst & Young released a study saying that more than a third of multinational corporations are planning new acquisitions of their competitors in the next six months, which should lead to an even greater increase in M&A activity. According to E&Y researchers, about 44% of companies are currently planning acquisitions in the next year or two, which is a fairly high level. In comments to Ernst & Young's Capital Markets Confidence Barometer, Rich Janere, vice chairman of the Americas transaction advisory firm, said: "Confidence is returning. In the US, companies are increasingly transaction-ready. 36% of companies are planning to make acquisitions in the next six months. Just six months ago this figure was 22%. Having surveyed more than 1 thousand top managers around the world in March, Ernst & Young researchers found that almost 60% of respondents believe that it is quite possible to talk about the end of the financial crisis within the next year. At the same time, a fifth of respondents believe that the negative phenomena for the global economy are already behind us. More than half of respondents (56%) believe that conditions in capital markets continue to improve, and 38% of respondents said they have no problems accessing financing for strategic projects and acquisitions. Pip McCrostie, vice chairman of international transactions consulting at Ernst & Young, says companies can aim for organic growth over the long term. “It is still difficult for companies to look beyond the horizon of the next six months. Therefore, if we talk about a longer period, they will most likely be more focused on organic growth than on M&A,” Mr. McCrostie believes.

How to spend a trillion

Among the main reasons for the sharp increase in M&A, experts cite the growing confidence of companies in the immediate prospects of the global economy and the huge cash that many American and European companies accumulated on their balance sheets from the second half of 2009 to 2010. Last week, Standard & Poor's senior analyst Howard Silverblatt reported that S&P 500 companies had $1.145 trillion in cash turnover in 2010, surpassing the previous record of $1.117 trillion set in 2006. The turnover of free cash in these companies also set a record - $495 billion (in 2009 this figure was $302 billion). At the end of last year, President Obama met with the heads of the largest American corporations - Boeing, General Electric, Dow Chemical, Duke Energy, Google, Intel, Cisco, Motorola, Comcast, AmEx, PepsiCo. “We focused on discussing the topic of employment and investment... They are optimistic that we will work together, that we can get all this cash out of the equation,” the president himself said after the meeting. When President Obama spoke of cash, he meant the cash that many corporations had already amassed. According to S&P, at the end of the year, the largest American companies in the non-financial sector had accumulated a total of $900 billion. Including financial corporations, the figure reached almost $2 trillion (for more details, see "Online" dated December 16, 2010). European companies have also concentrated significant amounts of cash - at the end of 2010, according to Bloomberg, the 466 largest European companies that make up the Stoxx Europe 600 index accumulated a total of about €500 billion.

Photo: REUTERS/Mark Dye-Newscast/Handout

This largely explains why a number of major M&A announcements recently were either largely or entirely cash-financed. Among the most striking examples is the purchase of American AT&T of its competitor T-Mobile USA from Deutsche Telekom for $39 billion announced on March 20 (of which Americans are willing to pay $25 billion in cash); Warren Buffett's investment company Berkshire Hathaway, announced on March 14, purchased chemical company Lubrizol Corporation for $9.7 billion in cash; The purchase of its competitor National Semiconductor for $6.5 billion in cash, announced on April 4 by the American electronics and components manufacturer Texas Instruments. Moreover, not the least role in this process was played by the policies of the American authorities, who continue to provide their market with significant volumes of liquid funds - by keeping the base rate at a record low level and the “quantitative easing” (QE2) program. "The US authorities wanted the QE2 program to lead to a revival of the economy, so that banks and companies would begin to invest in the development of new projects. But instead, banks and companies, as a rule, use this money to buy up their competitors. As a result, a situation is created that can be we can call it “meta-finance” - there is money, but the real economy does not receive it in full,” Professor Ismail Erturk, a senior lecturer in banking at Manchester Business School, noted in a recent conversation with Kommersant.

Buying up competitors is not the only way to use accumulated cash. Companies also spend it on repurchasing their shares from the market. Companies in the Standard & Poor's 500 index conducted 38% more share buybacks than a year ago, according to Bloomberg and research firm Birinyi Associates. Over the past three months, S&P 500 companies have initiated stock buybacks totaling nearly $150 billion, more than in all of 2009 ($125 billion) and the first three months of 2010 ($108 billion).

Another way to put free funds to good use is to use them to pay dividends, which is bound to please shareholders. Corporations that experienced one of their most profitable years in recent memory are increasingly allocating more money to pay dividends to shareholders, according to the latest Bloomberg survey. More than 130 companies that make up the S&P 500 index intend to do so in the next two months. JP Morgan Funds strategic analyst David Kelly said in an interview with the agency: “If companies cannot find a better use for accumulated cash, the best option is to transfer these funds to shareholders.” Arturo Bris, a professor at the Swiss business school IMD, agrees with him (see column).

We have

In Russia, according to bankers involved in corporate lending, the liquidity situation for companies in the real sector has also improved, but not for all of them. “During the crisis, Russian companies actively cut costs, thanks to which they became much more efficient. On the other hand, prices for raw materials, to which the domestic economy is especially sensitive, shot up again. Both of these factors led to the fact that many Russian companies in general good liquidity situation,” says Evgeny Retyunsky, deputy chairman of the board of Absolut Bank. Chairman of the Board of Otkritie Bank Vasily Zablotsky is less optimistic in his assessments. “The financial position of Russian corporate borrowers has indeed improved, however, since the depth of the crisis in Russia was generally greater than in the States, the liquidity available to the real sector can hardly be called excessive,” he believes.

However, as we emerge from the crisis, activity in the mergers and acquisitions market for those companies with abundant liquidity is gradually gaining momentum, points out Nikita Patrakhin, head of the corporate finance and investment banking operations department of Raiffeisenbank. However, most Russian players manage it differently than in the West, experts say. The main reasons are the ownership structure of Russian companies and the political aspect. “Large corporations in Russia are not fully public; they belong either to several owners or to the state, while the payment of dividends is a tool used primarily in public companies,” notes Mr. Retyunsky. “On the other hand, the issue of mergers and acquisitions for largest companies is primarily political; it requires approval at the highest level, which reduces M&A activity in the real sector." In such conditions, Russian corporations use excess liquidity primarily to pay off debts to banks, market participants note.

Evgeniy Khvostik, Daria Yurischeva

Question of price

Arturo Bris,

Professor at IMD Business School (Lausanne, Switzerland),

For years, consultants and academics have criticized the trend among companies to hold too much cash, since cash is one of the least desirable assets from the perspective of value-maximizing investors. In our jargon, cash is not our everything (as CEOs often say), it is simply "fat" because it makes companies larger, slower, less healthy and efficient. And the best way to get rid of fat (i.e. cash) is to exercise and get back in shape (i.e. investing, mergers and acquisitions) or have it surgically removed (i.e. payouts).

But our recommendations were not taken seriously. Cash holdings at S&P 500 companies will reach $1 trillion by the end of 2011, according to a recent JP Morgan Chase study. In turn, as Bloomberg calculated, the total cash reserves of the 466 largest European companies amount to $700 billion. This figure is simply staggering.

Why did companies have so much cash? The first reason, of course, is government policy. "Quantitative easing" (QE2) in the US has led to billions of dollars being injected into the economy through financial institutions. The Federal Reserve currently injects $75 billion into the system each month through securities purchases. The European Central Bank played the same game by providing cheap financing to Europe's struggling financial institutions. But this money eventually ended up on the balance sheets of industrial companies. It's no surprise that after 2008, the average cost of capital for a standard company was at an all-time low.

Large cash holdings of companies indicate a lack of good investment opportunities - be it organic growth or growth through mergers and acquisitions. However, companies have been stockpiling cash because the future funding situation is full of uncertainty, with inflation and rising interest rates possible.

Companies that are poorly valued in the market and do not have good investment prospects on the horizon have found nothing better to do than return money to investors. Since returns on capital are not guaranteed, dividends make securities investments attractive. So we will see a sharp increase in dividend payouts in the coming months. This is good for the global economy because we need more private sector spending to boost economic growth. Investors are already savvy, and since bond yields are low and securities are volatile, dividend payments will flow into personal consumption (in real estate, goods and services), which will ultimately lead to job creation and growth. As we science people like to say, “Cash is the fat, and cash flow (cash that converts into investment and consumption) is everything.”

Newspaper "Kommersant" No. 67/P dated 04/18/2011, page 13

Authors:

Cash needs