04/28/10

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Companies Puzzle Over Record Cash Hoards

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As they emerge from a crippling recession, U.S. companies are rolling in a record amount of excess cash. Now that the economy is improving, corporate boards are under pressure from investors to put their wealth to good use. But should they try to grow their existing businesses, invest in new ones, buy competitors, boost dividends, or repurchase shares?

“We like companies with healthy balance sheets,” says Cliff Draughn, chief investment officer at Excelsia Investment Advisors. “The question is whether they’re hoarding too much cash, and whether they should be spending some of it.”

A Standard & Poor’s analysis of large-cap companies found them with a record amount of cash and equivalents at the end of the fourth quarter. Excluding financial, transportation, and utility companies (which hold lots of cash to operate), S&P 500 companies had $831.2 billion in their coffers, 36.3% more than when the recession officially began at the end of 2007.

Bloomberg data based on the most recent reporting period show that the full S&P 500 has $1.28 trillion on hand, more than twice the $596.5 billion on hand in 2003 after the end of the last recession.

After deep spending cuts, companies keep pumping out cash. According to Bloomberg, the companies in the S&P 500 generated free cash flow over the past 12 months of $883.4 billion, 119% more than in 2006.

“WATER IN THE DESERT”
During the recession and financial crisis, there were good reasons to hold on to so much cash. “It’s like hoarding water in the desert,” says Peter Iannone, a managing director at CBIZ MHM (CBZ), where he has often served as temporary chief financial officer at public and private companies.

Companies needed to be sure they could survive a long, brutal recession and stay solvent, even if financial markets failed again, Draughn says.

Now that conditions seem to have improved, corporate boards and CFOs are feeling the heat to start using cash productively. As Bank of America Merrill Lynch (BAC) chief U.S. equity strategist David Bianco wrote Apr. 19: “Cash is accumulating quickly. Investors want an action plan.”

Which doesn’t mean investors will always be happy with the plan executives come up with.

INVESTING INTERNALLY
Last quarter, Google (GOOG) hired 786 employees worldwide, and cash fell 9.9% from the previous quarter, to $9.2 billion. (Including short-term securities, Google had $26.5 billion on hand as of Mar. 31.)

Yet “people worry they’re investing too aggressively,” says Jim Tierney, portfolio manager at asset manager W.P. Stewart, which owns Google stock. Google shares are down 14.6% since the start of 2010.

Tierney believes the best use for cash is Google’s chosen route. “The best thing that these companies can do is find ways to grow organically,” he says.

The problem with this strategy, however, is that customer demand isn’t sufficient in many industries to justify spending money on new employees or new plants, offices, and equipment, Iannone says. Until business conditions improve further, mergers and acquisitions could be a more efficient way to grow. “It’s a safer bet to acquire existing market share than try to build it,” he says.

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