AS EVERY SCHOOLCHILD knows, money burns a hole in your pocket. This truism does not necessarily translate to the corporate boardrooms of the world’s largest companies, but if it does the next few years should be interesting. Cash hoarding by corporates since 2007 means that by some estimates there is now $3 trillion sitting on corporate balance sheets worldwide – $1 trillion on US corporate balance sheets alone. In November 2010 Morgan Stanley published research calculating that cash levels at US investment-grade corporates are at their highest level in two decades. There must be quite a lot of pockets on fire.
The M&A teams at the large investment banks certainly hope so, and have been predicting a boom in M&A activity in 2011 for some time. They must have their fingers firmly crossed in Europe – according to Thomson Reuters, fees from advisory work and underwriting activity in the region totalled $4.3 billion for 2011 to date, a 6% decline year on year, and fees from debt capital markets underwriting activity have fallen 8%. But in the US M&A activity is surging, chalking up a record of $257 billion of deals in the first quarter of this year alone. Elsewhere, by March deals involving Chinese targets totalled a record $27 billion for year-to-date 2011, 16% up on last year.
The assumption that corporates will come under pressure to put some of their cash piles to work is not unreasonable. However, predictions of a global M&A boom might be optimistic. So many conflicting factors are at work that many corporate pockets might now be lined with asbestos. First of these is the lesson that many learnt the hard way in the crisis: liquidity – there when you don’t need it, not there when you do. It will therefore be some time before corporate treasurers relax their conservative approach. The simple calculation of looking at cash as a percentage of market capitalization might no longer hold. "The requirement for liquidity has risen and people are being careful," says Larry Slaughter, senior banker for JPMorgan’s EMEA corporate clients. "Companies have learned to have sufficient liquidity." And it takes a lot more than just money in the bank to trigger deal flow. "It is simplistic to assume that because there is so much cash on balance sheets there will be knock-on M&A," says Matthew Ponsonby, co-head of M&A EMEA at BarCap. Corporates need three things to embark on an acquisition: confidence in the earnings outlook of the target, confidence in their own business and confidence that they have the support of shareholders for the deal. "The strategy must be right," says Mark Warham, co-head of M&A EMEA at Barclays Capital in London. "It is about teeing things up correctly and taking your shareholders with you." Requirements one and two on this list are difficult to achieve in an environment of uncertainty. "M&A is usually a feature of a rising market and people in Europe are less bullish on the economic outlook than their US counterparts," says Slaughter. Nevertheless, although these are unusual times the rules of corporate finance mean that sooner or later corporate cash balances will come down, or – in the words of Bank of America Merrill Lynch head of international M&A Adrian Mee: "Companies will generally seek to move to a place where their balance sheet structure is efficient." That usually means one or more of three things: share repurchases, special dividends or acquisitions.
The logic behind share buybacks is straightforward – they boost the share price and improve return on equity. But they are not always popular with investors if they feel there is not enough left in the till for acquisition opportunities. It is for this reason that recent share buybacks have been concentrated in the resources sector, which is particularly flush with cash thanks to the continuing surge in commodity prices. There have consequently been large buybacks at Rio Tinto and BHP. In February, Rio Tinto announced that it would buy back $5 billion of shares before the end of 2012, less than two years after it raised $15.2 billion via a rights issue. The company added $9.5 billion to earnings in 2010 thanks to high prices for such commodities as iron ore, copper, coal and aluminium. In the same month Anglo-Australian mining conglomerate BHP Billiton – under pressure from shareholders and having just racked up a 74% increase in half-year pre-tax profit to £9 billion ($14.7 billion) – announced a £6.2 billion buyback, together with a commitment to spend a further £50 billion on development.
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"In a low interest rate environment with a risk of inflation cash is not a good place to be"
Larry Slaughter, JPMorgan |
Buybacks on this scale are the exception rather than the rule. However the concept could become more common among smaller firms as corporates begin to feel the weight of the cash at their disposal. South African insurer Sanlam, for example, has earmarked R4 billion ($580 million) discretionary capital for acquisitions, share buybacks and expansion in India, R1 billion of which will be for a share buyback.
But Slaughter at JPMorgan does not agree that more corporates will conduct buybacks. "The institutional investor base wants companies to do things that are strategically sensible and will reward them for it," he says, pointing to the fact that the share price performance of acquirers has been positive in absolute terms and relative to the market. Examples of this include the proposed mergers of Deutsche Börse and NYSE Euronext, ABB and Baldor, and Sanofi-Aventis and Genzyme. "In a low interest rate environment with a risk of inflation cash is not a good place to be. But investors favour growth and dividends over share repurchases. They want growth that they can touch and make sense of." Others agree that higher dividends are more likely – along with its buyback Rio Tinto announced an increase in its final dividend from 45c to $1.08.
