Corporate cash piles have risen continually since the financial crisis and are now at historic highs.
There has been widespread criticism of companies for hoarding cash, but at least they are well buffered against shocks. Corporate defaults and bankruptcies should be a thing of the past, shouldn’t they?
But the devil is in the detail. The corporate cash mountain is concentrated in a small number of companies, predominantly technology and pharmaceutical. According to S&P, at the end of 2016, more than half of an estimated $1.9 trillion in cash or cash equivalents on corporate balance sheets was held by 25 companies.
McKinsey estimates that $1.5 trillion is excess cash, of which three-quarters belongs to just 10 companies. Wealth inequality is not just a household phenomenon.
Underlying the cash mountain is rising debt. For giant cash-rich corporations, parking cash in low-tax jurisdictions and issuing bonds to obtain cash for operations is an efficient way of managing a balance sheet.
The bonds are effectively cash collateralised, which keeps bond yields well below the tax rate on repatriated cash. That is true not only for the US, but for many other countries, too.
The exceptionally low interest rates of the past decade have created an incentive for companies to keep cash offshore and borrow onshore.
President Trump’s tax reforms may disrupt this practice, if the tax cut proves sufficient to make bringing cash onshore attractive. Early indications are that cash is coming home: the Federal Reserve reports in line 6 of this table that foreign earnings held abroad by non-financial companies fell by $632.7bn in the first quarter of 2018.
But repatriating cash hoards doesn’t necessarily make them shrink. If anything, cash reserves are increasing: according to the same Fed data, gross corporate savings are now over £2.1 trillion.
Of course, it is early days yet. Companies may still offload the cash they have repatriated. However, if the Trump administration was hoping they would do so in the form of new plant, equipment and jobs in the US, it may be doomed to disappointment.
There was never anything to stop tech and pharma giants investing their cash mountains. That they didn’t do so suggests that the returns on that investment would be too low to make it worth their while.
Highly successful companies can find it virtually impossible to come across sufficient productive investments to absorb their cash revenues. Alphabet, Amazon, Apple, Facebook and Microsoft are each globally dominant in their own niche, which means they face little price competition.
Arguably, therefore, their profits are higher than they would be in a more competitive market. This could help to explain their inability to find productive uses for their vast cash hoards.
If cash reserves are large enough, no regulatory fine can force a company to change its behaviour
Usually, companies return excess cash to shareholders, either as higher dividends or by buying back shares. It seems likely that this will be the eventual fate of much of the cash repatriated to the US.
But it might take quite a while. Some of the giants make money from their cash reserves by lending them to other corporations.
For example, Apple’s offshore cash hoard is mostly not in the form of cash or near-cash equivalents such as US treasuries. Much of it is held as corporate bonds, mainly in other tech companies.
The last thing Apple needs is to spook a general fall in tech bond prices by dumping its holdings to buy back its own shares.
And not all of the cash will necessarily find its way back to shareholders anyway. The Economist magazine says the enormous cash reserves that these companies have built up is a form of self-insurance.
In July 2018, Google was hit with a €4.34bn fine by EU regulators for “abusing the dominance” of its Android operating system for smartphones. This followed on from a €2.42bn fine in 2017 for favouring its own consumer shopping services in internet searches.
Tellingly, Alphabet, Google’s parent company, treated both fines as a cost of doing business. If cash reserves are large enough, no regulatory fine can force a company to change its behaviour. Anti-trust regulators may need stronger ammunition.
At the opposite extreme from the cash-rich tech and pharma giants, the high-tech manufacturer Tesla is burning cash at an extraordinary rate.
In the first quarter of 2018, it got through $1.1bn, depleting its cash balances by $800bn. The rating agency Moody’s warned at the time, that if it didn’t get its cash burn under control, Tesla would need a rights issue later in 2018. Tesla’s co-founder and CEO, Elon Musk, irritably brushed off the criticism.
But it is now evident that Tesla is suffering cash distress. It has asked its suppliers to keep it going by refunding some of the money it paid them as long ago as 2016.
To be sure, high-tech manufacturing requires considerable upfront investment. Tesla argues that investors will see returns in due course, though it has yet to show a profit in 15 years. This raises an interesting question. Tesla is cash poor, but it is innovative.
Apple was once cash poor and innovative, too. Now, Apple is hoarding cash – but what has happened to its innovation? Maybe what Apple is suffering from is not so much an excess of money as a lack of imagination.
It’s not just Tesla that has taken a cavalier attitude to cash management. Some outsourcing conglomerations have been running asset-light, highly leveraged balance sheets with not much in the way of free cash.
Normally, such a strategy would make them a poor investment. But banks and investors thought that because of the outsourcers’ growing dominance in public-sector construction and services, they were implicitly backed by government. That is, until the failure of Carillion in January 2018.
Carillion literally ran out of cash. By the time it filed for compulsory liquidation, it had only £29m left, all of it encumbered by existing obligations. But its accounts showed that its debt obligations had exceeded its cash reserves by quite a margin since 2016, and it had almost nothing in the way of recoverable assets.
It had been gambling for resurrection throughout 2017, relying on short-term borrowing to service existing debts, while taking on more and more contracts in the hope of generating sufficient cash flow to break the downward spiral.
When its banks pulled the plug on short-term funding, and the UK government refused to provide it with a bridging loan, the game was up.
The UK government’s refusal to bail out Carillion amounted to withdrawal of a ‘too big to fail’ guarantee. Suddenly, the outsourcing sector looked vulnerable. Share prices fell across the board.
Capita immediately announced a rights issue and restructuring plan; other outsourcers quietly started deleveraging. Cash is now king again in the outsourcing sector.
Cash should be king among second-tier companies, too. But according to S&P, aggregate cash holdings of companies outside the top 25 were only $875bn at the end of 2016. Meanwhile, aggregate corporate debt has risen to $5.1 trillion, and corporate leverage is higher than it was before the financial crisis.
S&P says companies should deleverage before returning cash to shareholders. It warns that it might downgrade companies that don’t do this.
It is a timely warning. Central banks are beginning to raise interest rates, potentially threatening the solvency of highly indebted companies.
The economic outlook is becoming increasingly uncertain as trade tensions rise. In the UK, Brexit threatens to disrupt supply chains. In the light of all this, cash-rich balance sheets look attractive.
Companies may need to adopt a more cautious approach to financial management, building up reserves and paying down debt.
Frances Coppola writes and speaks about banking, finance and economics
This article was taken from the October/November 2018 issue of The Treasurer magazine. For more great insights, log in to view the full issue or sign up for eAffiliate membership