Cash as a Liability
Is Cash – A Quintissential Strategic Asset – Now a Liability? Some Actually Think So!
We pose this question not merely out of curiosity. It was not that long ago (i.e., the Credit Crisis of eight years ago) that some corporations frantically raised debt and equity through desperate means to obtain cash and improve their credit in a lending market that had all but closed. In the aftermath, the most gifted CEOs, typically owner-operators, were identified as those who deliberately held plenty of cash. Have times changed or what?
Shareholders now increasingly demand companies deploy, not save, cash through share repurchases, dividends, or acquisitions. Their reasoning is simple: returns on cash and cash equivalents are insufficient. Returns on capital and earnings per share will be higher if cash is spent, even if it earns only a few percentage points.
CEOs appear to be listening. There is a rather voracious appetite to acquire assets, otherwise known as the mergers and acquisitions (“M&A”) market. Here are a few examples, all from announced transactions during the first half of 2016.
Danone, a global food and beverage conglomerate, is offering to acquire WhiteWave Foods Company, a maker of organic food products. Organic is perhaps the fastest growing segment within the food and beverage industry, and Danone clearly wants in. WhiteWave is forecasted to earn $1.40/share this year. Relative to the offer price of $56.25, this is a P/E ratio of 40.2x. Some might contend this is expensive for a consumer staple company.
Microsoft recently announced that it is acquiring LinkedIn for $196/share in cash. Microsoft has made no secret its desire to expand its social media portfolio – at almost any price. LinkedIn might earn $3.45/share this year, implying a 56.8x earnings multiple.
Softbank, a Japanese holding company run by Masayoshi Son, and owner of Sprint, is acquiring ARM Holdings, a chip-maker for handheld devices, for 1,700 pence/share. ARM is expected to earn 35.58 pence/share in 2016, implying an acquisition P/E of 47.8x. ARM, of course, operates in one of the most competitive industries in the world that is subject to cyclicality and margin erosion, technology equipment.
Finally, only in America. Global consumer product conglomerate Unilever is purchasing Dollar Shave Club for $1 billion. Dollar Shave Club, a California-based start-up, offers a membership-based alternative to the high-priced razor market dominated by Gillette. Unilever suggested that Dollar Shave Club might generate $200 million in revenues this year. However, it has been reported that this business makes no money. Isn’t it hard to imagine that a company which can produce $200 million in sales, earns not even a penny of profit? Unilever might soon find out why.
All of these acquisitions (and there are more) have occurred at multiples above 40x earnings. Is this a sign that CEOs are becoming increasingly uneasy and aggressive with their deployment of cash? One could certainly argue that. These types of acquisitions, which are becoming more common than not, at a minimum, should make equity investors question a principle seemingly ignored of late – valuation.
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