This article was first published in the March 2012 UK edition of Accounting and Business magazine
Having a large pile of spare cash has never been so much trouble. At the end of November 2011, British non-financial companies were sitting on £247.8bn of cash and deposits in their UK bank accounts.
The money has been building steadily since Britain slipped into recession. And although the rate of growth has levelled off in the past year – the comparable figure for November 2010 was £247.6bn – it’s still a cash mountain which could give companies business firepower in the year ahead. Put in perspective, it’s more than three times the size of the Bank of England’s current round of quantitative easing.
So what will corporate Britain do with it? And why might owning all this cash cause so much trouble? The problem arises because there are three competing strategies tugging at that cash pile.
First, corporate treasurers want to cling to it like a comfort blanket in case bank lending dries up even further in the wake of more twists and turns in the sovereign debt crisis. They will be aware of a warning in a recent Bank of England’s Financial Stability Report that the future growth of bank lending is by no means certain in the present febrile economic climate.
In fact, the reason that companies are holding so much cash is that they’ve been scared by the breakdown of normal banking following the credit crunch. As Capita Registrars noted in its 2011 Q3 UK Dividend Monitor Report: ‘Anecdotal evidence suggests corporate balance sheets are rather cash rich at present as companies hoarded cash for fear of not having access to bank lending during the crunch.’
‘If you think the business environment is going to deteriorate so that you’ll need the money, you hang on to it,’ notes David Simpson, global head of mergers and acquisitions (M&A) at KPMG.
But the second pressure tugging on that cash pile comes from shareholders looking for increased dividends. With other asset classes – bonds, property – either providing meagre returns or being difficult to realise in illiquid markets, investors have been ramping up pressure for improved dividend payouts. And companies seem to have been responding.
Capita Registrars’ Q3 report – the most recent available at the time of writing – notes that dividend payouts from quoted companies rose in the five consecutive quarters up to the second quarter of 2011. (The figures were adjusted for one-offs and BP’s cancellation of its £5.4bn of dividend payments in 2010.)
In the first half of 2011, 403 companies paid a dividend – an increase on the 372 on the same period of 2010 and as few as 333 in the first half of 2009. Even so, the number paying dividends was below the peak of 410 in the first half of 2008, before the recession following the 2007 credit crunch started to bite.
In all, Capita expected UK dividend payments to total in the region of £66bn in 2011, £9.5bn more than in 2010. There were some particularly large payers. These included the life insurance company Resolution, which was planning to return a total of £500m to shareholders over the course of a year. The mining company Antofagasta paid a special £540m dividend, on the back of soaring copper prices.
Capita noted: ‘Dividends are providing the opportunity for investors to insulate themselves against the declining real value of income, as companies taken as a group should be able to increase their prices in line with inflation.’
Simpson notes: ‘If you’ve got confidence for the outlook of your own particular company or business and you’ve got excess cash, you may well be returning it to shareholders.’
But although there is undoubtedly pressure from investors to get their hands on more of that cash pile, there is also a dilemma for boards. When they’re sitting on a pile of cash, they can afford to be more generous with dividends, but in doing so they set a benchmark for the future among investors which it may not be possible to maintain – especially in another economic downturn.
‘When you’re running a quoted company, you have to think very carefully about the precedent you set when you decide on a dividend rate,’ warns Simpson. ‘There could be an expectation among investors that they can bid you up from there. The normal dividend rate should be a long-term decision.’
So, although most crystal balls are cloudy, 2012 could see a slowdown in the current growth of dividend levels. Indeed, when figures for Q4 2011 come through, there is a chance they could show that slowdown had already begun.
To acquire or not to acquire
Which leaves boards thinking about the third pull on their cash piles – making acquisitions. The consensus view among M&A specialists is that 2012 could see a significant uptick in global activity. Doing the Deal 2012, a new survey of deal-makers responsible for 10% of global M&A, carried out by Mergermarket, found that more than half (53%) expect an upturn in 2012.
‘A potent mix of buy-side and sell-side deal drivers is expected to boost M&A in the next 12 months,’ says Matthew Albert, research director for Remark, a unit of Mergermarket, and author of the report. ‘During this period, respondents see consolidating industries, cash-rich corporate buyers and strong private equity deal flow as the top three buy-side drivers.
‘These will be matched with ample opportunities on the sell side as attractive valuations, private equity exits and non-core asset sales come to the fore in 2012.’
But Simpson sounds a note of caution, citing two factors that may stop companies doing M&A deals. ‘The first is if Britain or parts of the world go back into recession,’ he says. In this climate, ‘price discovery’ in M&A deals – agreeing the price of the transaction – becomes difficult because the previous asking price may have been rendered obsolete by falling demand for the takeover target’s products.
Second, if future prospects are uncertain, investors may actually urge a company to continue sitting on its cash pile rather than use it in a possibly speculative acquisition. ‘There is a strong tendency at times of great uncertainty to defer making decisions for a month or two,’ notes Simpson. ‘We’re seeing quite a lot of that.’
That word of caution is reinforced by Paul Siegenthaler, one of the world’s high priests of M&A. His book, Perfect M&As: the Art of Business Integration, is a standard text. He warns that many M&As have failed to create new value for shareholders. ‘If the business case does not appear blatantly obvious to the shareholders, how can one expect to create traction for the business integration with the other stakeholders – such as employees, works councils, trade unions, local authorities, the media and so on?’ he asks.
The losing game
‘Shareholders tend to vote in favour of a merger or acquisition assuming all will go well, when in fact a majority of M&As do not deliver their promise,’ he adds. ‘Shareholders should assume they will lose out, unless the board can convince them of what will be implemented differently in their proposed plan.’
In a warning to corporate finance teams, Siegenthaler notes that the past four years have made investors more cautious. ‘Until then, the prospect of huge gains through high leverage and a lack of understanding of the factors that can lead M&As to failure, even when based on a sound strategy, caused many mergers and acquisitions to appear overly attractive,’ he says. ‘Sensitivity analysis shows that in many instances variations in the hypotheses underlying the business case for a merger or acquisition can rapidly turn that business case into a negative value.
‘In the current climate of economic fluctuation, many M&A projects therefore still present too much risk and uncertainty. Poor growth prospects in Europe are not, in themselves, a sufficient reason to refrain from making an acquisition or merger in that area, whereas the uncertainty of a likely outcome is a strong deterrent.’
In the short term, it seems the conflicting pressures on the cash piles – hoard, distribute, invest – may lead boards and finance teams to take the safe option. Keeping a cash pile may seem the antithesis of clever financial management – the equivalent of stuffing savings under a mattress – but when nobody is quite sure what’s going to happen next, it is the safety-first option. No CFO ever got fired for keeping a tight watch on the money.
Peter Bartram, journalist
THE HIDDEN TRAPS OF M&A:
Any CFO or board sitting on a cash pile and believing that mergers and acquisitions (M&A) are a route to easy money should think again.
Last June Rupert Murdoch’s News Corporation sold the social media site Myspace for US$35m, a fraction of the US$580m he paid for it in 2005. But Murdoch’s faux pas pales into insignificance alongside the merger between AOL and Time Warner.
When the firms linked together in 2000, AOL had a reported market value of US$200bn and Time Warner US$160bn. When they split in 2009, AOL’s market value had slumped to US$2.5bn, scarcely more than 1% of its original worth. Time Warner’s market value had collapsed to US$36bn.
‘Regardless of the economic outlook, the two core elements of successful M&A are picking the right deal and delivering a first-class integration,’ says Pip Peel, founder and vice-president of PIPC, a worldwide consultancy which has delivered some large-scale merger integrations.
‘The first is about the strategic fit, performing adequate due diligence and paying the right price for the asset being acquired. The second part is about planning what the joint business will look like and executing a strategy to realise that end state as quickly as possible, while maintaining critical business functions and people. The ultimate result of the two, if successful, will be reflected through increased shareholder value.’