When Your Company Has Too Much Cash

Since CFO Innovation started surveying financial executives in Asia in September last year, we have detected a consistent pattern in company intentions regarding cash on the balance sheet. The majority of the region’s companies will either increase their cash holdings (38% today, from 42% last year) or keep them at the same levels (39% today, from 35% last year). Only a fifth will draw down their pile of cash.

 
A new analysis by Moody’s Investors Service adds more detail to this general trend. The credit-ratings agency examined the balance sheets of 120 non-financial corporates in Asia for which it has issued credit ratings. It found that this group holds about US$230 billion in cash – up nearly 60% from the end of 2008.
 
“Non-financial corporates in the emerging Asian markets (excluding Australia and Japan) are cash-rich, despite noises over global economic conditions,” says Moody’s in a special report issued on November 15. “In addition to covering annual capital spending, dividends, and short-term debt, these cash holdings will support further expansion and could serve as an acquisitions war chest.”
 
Too much cash?
Is it a good thing, though? For CFOs, the dilemma in holding so much cash is that the money does not do much for the bottom line. With interest rates at historic lows, bank deposits yield pitiful returns. The CFO can argue that the 1997 Asian financial crisis and the recent global crisis have underlined the need for a cash cushion at all times. Granted, but isn’t it counterproductive to have not just a cushion, but a bulging mattress and several fat pillows as well?
 
The question can be asked of China Mobile. According to Moody’s, the mainland’s dominant telecom provider had US$46.8 billion in cash, cash equivalents, deposits, and short-term investments as of June 30, 2010 – equivalent to 35% of the total cash holdings of the region’s top 15 companies (ex-Australia and Japan) that have the largest cash hoards (see table below). Its cash-to-debt ratio is 400%, far higher than the average 38% among the other Asian corporates in the list.
 
Asia’s Top 15 Cash-Rich Listed Companies
 
Cash
(US$ billion)
China Mobile (Hong Kong/China)
46.8
Samsung Electronics (Korea)
18.4
Hutchison Whampoa (Hong Kong/China)
13.0
Hyundai Motor (Korea)
7.3
CNOOC (Hong Kong/China)
6.8
Reliance Industries (India)
6.5
POSCO (Korea)
6.4
Genting Berhad (Malaysia)
5.3
LG Electronics (Korea)
5.0
Jardine Strategic (Hong Kong/China)
4.3
NTPC (India)
4.2
CITIC Pacific (Hong Kong/China)
3.2
San Miguel (Philippines)
2.6
Tenaga Nasional (Malaysia)
2.5
MISC (Malaysia)
2.4
Source: Moody’s Investors Service. As at June 30, 2010, except
for Tenaga (May 31, 2010) and Reliance and NTPC (Sept. 30, 2010).
 
It is, of course, not easy to balance the need to armour the company against a financial crisis and to optimise usage of cash to enhance shareholder value. Even when the CFO has a rough idea of how much to hoard and how much to spend (perhaps that 38% average cash-to-debt ratio holds a clue), he or she will still be faced with the question of how best to squeeze optimum usage out of the cash.
 
Moody’s observes, for example, that the cash holdings of Asian corporates are mainly in the form of cash and deposits. In contrast, a higher proportion of cash in U.S. companies are in short-term investments. The relatively higher risk these investments carry may explain why Asian corporates are lukewarm about parking cash with them.
 
Risk mitigation
But there are ways to mitigate the risk, argues Gail Le Coz, CEO of Institutional Money Market Funds Association in London, who describes money market funds as “a popular solution for short-term cash management, enabling treasurers to manage their market risk exposure and still obtain competitive money market returns.” The key is to choose fund managers who maintain a maximum weighted average maturity (WAM) of 60 days. “The higher the WAM, the greater the impact of a change in interest rates on the value of the fund,” Le Coz writes in gtnews.com.
 
In an environment where interest rates are likely to increase, as is the case in Asia right now, the prudent money market fund manager may shorten the overall duration of the portfolio, allowing for quick reaction to any interest rate rise. On the other hand, where the interest rate environment is stable or where rates are likely to fall, the manager may opt for a longer WAM, in order for the fund to benefit from higher yields on longer date assets.
 
“The WAM limit provides an effective mitigant to market risk,” Le Coz explains. “If a MMF [money market fund] has a WAM of 60 days and experiences no net redemptions, it should be able to absorb a 300 basis point interest rate rise in one day and still maintain a constant net asset value of 1.00. Even with redemptions of 30% of assets in a given day, a MMF should maintain its constant value despite a 200 basis point interest rate rise. Most funds operate with a WAM in the region of 30-40 days, meaning that they should withstand even higher movements in interest rates on a single day without experiencing any impact upon the value of a share.”
 
New markets – and some M&A
What about the spending side? When the company finally gets around to spending part of its cash hoard, there is any number of ways to do it. Should it focus on growing existing businesses? Should it expand into new business lines? Should it make a move on competitors? Is it better to increase dividends? Should the company do a share buyback and boost the stock price? Or should it be a combination of two or more of these courses of action?  
 
“We believe that the build-up of cash in Asia is less a reaction to the global credit condition than a way to support future growth and expansion, as well as providing a general liquidity buffer,” Moody’s reckons. It expects part of the cash to eventually end up funding new capital expenditures. Indeed, the CFO Innovation Asia Business Outlook Survey for the Fourth Quarter 2010 finds an increase in the proportion of respondents who say their company will increase capital spending in the next 12 months, from 40% in the third quarter survey to 49% today.
 
The cash hoard will also come in handy for expansion into new businesses and markets. Asked to identify and rank the top three priority business areas their company will focus on in the next 12 months, 72% of the CFOs and other executives surveyed pointed to expansion in new consumer segments and/or geographical markets. The majority (55%) also plan to renew their focus on sales, marketing and distribution, which can mean a significant drawdown of cash reserves if the initiative includes hiring new sales staff and building additional distribution channels.
 
The CFO Innovation Asia survey finds, however, that acquiring assets (M&A) is way down in the list of business priority areas, with only 10% of respondents saying it is a top-three focus. Still, Moody’s expects some of the especially cash-rich companies to look at M&A opportunities. It notes that the Korean steel producer POSCO, which is sitting on US$6.4 billion in cash, has spent US$3 billion on its acquisition of Daewoo International Corp. since June 2010. Meanwhile, Korean carmaker Hyundai Motor is ready to spend as much as US$3.6 billion, which is half of its US$7.3 billion hoard, for control of Hyundai Engineering and Construction.
 
Whatever they do, however, it is probably not a good idea to exhaust the pile of cash Asia’s companies have so patiently built up. Moody’s says it “views persistent high cash balances positively. They are a reflection of strong liquidity, which provides financial flexibility and serves as an important buffer during times of uncertainty.” Just make sure you get a reasonable return from holding idle cash.

About the Author
Cesar Bacani is senior consulting editor at CFO Innovation.
 
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