Are High Corporate Cash Balances Constraining Investment?

 @moranzhang on December 13 2012 7:20 AM
US Dollar Currency
Reuters

Since the global financial crisis, commentators in a number of advanced economies have pointed out that companies have been hoarding ever larger sums of liquid assets as they seek to build a buffer against further turmoil – a move that could eventually harm their competitiveness.

Bank of Canada Governor Mark Carney took a rare swing at corporate Canada in August, accusing companies of sitting on huge piles of “dead money” that should either be invested productively or returned to investors. While acknowledging that companies are wary about the global economy’s prospects, he added that “the level of caution could be viewed as excessive.”

“Their job is to put money to work, and if they can’t think of what to do with it, they should give it back to their shareholders,” Carney said.

Things are no better in the U.S.                                                        

American companies held a whopping $1.74 trillion in cash and other liquid assets at the end of the third quarter, the Federal Reserve said last week. That is $44 billion more than three months earlier and more than erases the prior quarter's slight decline.

Holding huge amounts of cash often goes hand-in-glove with reduced capital investments, or "capex." At U.S. corporations rated by Standard & Poor's, capital investments declined significantly through the recession, falling about 21 percent in 2009, while revenue declined 13 percent. Even as the economy recovered in 2010 and beyond, capex growth did not exceed revenue growth until 2011.

In all, S&P estimates that cash savings from deferred capex amounted to about $175 billion from 2009 through 2011 for about 1,400 companies.

In a report to be released Wednesday, S&P described the underinvestment as "unsustainable" and warned that “if left unchecked, underinvestment could lead to loss of competitiveness and in turn, lower profitability, potentially hampering issuers' access to credit markets in time of need.”

Robust credit market conditions in 2012 have led to favorable refinancing terms for many issuers.

In late November, the No. 1 e-retailer Amazon.com, Inc. (NASDAQ:AMZN) tapped the capital market with its first bond offering since 1998. Only a week later, the No. 1 chipmaker Intel Corporation (NASDAQ:INTC) announced it sold $6 billion in bonds to fund stock buybacks and other business activities.

However, given the current fragile global economic landscape, S&P warns that issuers who have sacrificed long-term investments for short-term liquidity benefits will find their competitive positions significantly weakened and their ability to borrow diminished when they need it most.

“With margins already cut to the bones, however, any external shocks (domestic or overseas) could shrink profitability and the cash flow needed to fund the necessary investments,” said Andrew Chang, Standard & Poor's credit analyst, in the report.

Furthermore, despite good growth through the first half of 2012, business spending appears to be declining once again, according to Commerce Department data released Nov. 29, indicating potential scaling-back of long-term investments entering 2013.

And the latest Business Roundtable Survey of U.S. chief executives -- which gathered views from 143 of the country’s leading company heads -- found them to be gloomier about the economic outlook.

CEOs anticipate continued slow overall economic growth for the next six months and have slightly lower expectations for sales and capital expenditures. This follows a significant drop in expectations in the prior quarter.

Cash Trapped Overseas

Continued build-up of overseas cash due to taxes on repatriation -- profits that foreign subsidiaries earn are subject to tax rates as high as 35 percent if companies bring them back to the U.S. -- is also increasing liquidity.

In a report earlier this year, JPMorgan Chase & Co. (NYSE:JPM) analyst Dane Mott found that only about 600 of 1,000 U.S. multinationals that have kept foreign profits overseas broke out how much cash they held outside the U.S., according to The Wall Street Journal. For those companies, about $588 billion, or about 60 percent of their total cash, was held overseas. Meanwhile, top U.S. companies generate only about a third of their revenue outside the U.S., according to Thomson Reuters.

Based on research of the top 10 cash holders that break down their cash reserves by region,  S&P’s found that five companies -- Microsoft Corporation (NASDAQ:MSFT), Google Inc. (NASDAQ:GOOG), Cisco Systems Inc. (NASDAQ:CSCO), Oracle Corporation (NASDAQ:ORCL) and Amgen Inc. (NASDAQ:AMGN) – held 79 percent of their cash overseas as of third-quarter 2012. This is up from 77 percent as of yearend 2011.

“We don't see this trend reversing in the near term absent tax reform to encourage return of cash to the U.S.,” Chang said.

Apparently, these multinationals are cash-rich abroad and cash-poor at home.

Apple Inc. (NASDAQ:AAPL) had 68 percent of its $121 billion in cash and investments outside the U.S. at the end of September. General Electric Company (NYSE:GE) had only about a third of its $85.5 billion in cash in the U.S., even though the U.S. accounted for about 45 percent its total revenue. Illinois Tool Works Inc. (NYSE:ITW) had had $2.1 billion in cash, but none of that was in the U.S., where it generates more than 40 percent of its revenue.

At the end of last year, Johnson & Johnson (NYSE:JNJ) kept all of its $24.5 billion in cash outside of the U.S., which accounted for 46 percent of its overall revenue. Meanwhile, Whirlpool Corporation (NYSE:WHR) had 85 percent of its cash offshore.

Why Aren’t Companies Spending?

The average level of liquid assets is misleading in countries where much of the cash is held by a small number of firms, notes Andrew Kenningham, senior global economist at Capital Economic.

For instance, in the U.S., a handful of technology companies hold huge amounts of cash. By contrast, many manufacturing and services companies hold much less. Moody’s estimates that the liquid assets held by U.S. manufacturing companies fell by 23 percent during 2011. So it would be inaccurate to suggest that all firms are sitting on unusually high cash balances.

“It would be misleading to argue that high corporate cash balances are a major reason for investment being so weak,” Kenningham said. “There are plenty of other candidates to explain the disappointing rates of investment, with the U.S. fiscal cliff and concerns about the euro zone at the top of the list.”

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