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Cash reserves and M&A options



The abundant cash reserves of many of Corporate America’s biggest businesses are causing many to wonder just how these companies are going to start spending their money.

Recent research published by Standard and Poor (S&P) Capital IQ has shown that 202 members of the S&P 500-stock index currently hold $1 billion or more in cash – not including banks, which keep ready cash in a different way to other businesses.

Oil giant, Chevron, has around $21 billion in its cash hoard, according to recent company reports, with Apple sitting on $16 billion, Johnson & Johnson on $14.9 billion and Google on $14.8 billion. Writing in USA Today, financial reporter and columnist, John Waggoner, said that the depths of these cash stores could prompt companies to engage in significant merger and acquisition (M&A) activity as pressure grows to make use of the funds, which are likely to be earning relatively little for the companies.

“Sooner or later, shareholder grumbling may force them to dip into the massive amounts they have tucked away in cash or equivalents, earning very little,” he explained. “For investors, the question isn't whether they will spend it well, but who will benefit.”

The amount of cash that these companies hold is a curious outcome following years of economic crisis. The global downturn, however, has not stopped the relevant companies from earning record profits, with the S&P 500 racking up profits in 2012 that have never been seen before in history.

Amy Dittmar at the University of Michigan’s Stephen M. Ross School of Business and Ran Duchin at the University of Washington’s Michael G. Foster School of Business, recently carried out and published definitive research on the matter of the enormous funds. They stated that financial managers and chief executives have developed a “special reverence” for cash reserves in the wake of a soul-searing downturn.

Dittmar and Duchin wrote: “We find that CEOs who were previously employed at a firm that experienced financial difficulties have a cash-to-assets ratio that is 3.1 to 4.4 percentage points higher compared to firms whose CEOs did not experience financial difficulties.”

In order to make use of the money, many companies are increasing dividends and buying back shares, although this does little to grow the core business of the companies and is perceived by some as lazy. The money could instead be used to poach employees from rival businesses at a reasonable price or invest in new equipment or in smaller businesses, the operations of which could be absorbed into the larger organization. Such actions would be particularly beneficial – and manageable – in times of slow economy and would subsequently pay off in an upturn.

S&P senior index analyst, Howard Silverblatt, told USA Today that the technology sector is sitting on the highest cash levels of all industries, with companies holding on average around 40 per cent of their values in cash. The healthcare sector has the second highest proportion of cash, with some 20 per cent. Silverblatt said: “Cash levels are knee-high, if not waist-high.”

If companies choose to spend their cash wisely – using it to grow and invest in their business – then it has the potential to contribute very positively to the national economy, helping it to start humming again and creating more jobs. Silverblatt warned, however, that although the money is there, companies are wary about making poor acquisition decisions, not wanting to overpay for companies they do wish to take on. He said: “It’s not that they don’t have the cash to spend, it’s that they are choosing not to.”

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