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January 21, 2014 7:03 pm
A growing number of big US technology companies are heeding the call from Wall Street to hand more of their excess cash back to shareholders. But that does not look likely to stop a huge build-up of liquid reserves that has already left the sector with a cash mountain of historic proportions.
By the middle of last year, the concentration of wealth in the hands of a few tech winners had left just six companies – Apple, Microsoft, Google, Cisco, Oracle and Qualcomm – with more than a quarter of the $1.5tn held by US non-financial corporations, according to rating agency Moody’s.
With nearly $150bn in its coffers, Apple alone was sitting on close to 10 per cent of corporate America’s cash.
Behind this build-up lies a boom in profits in an industry that often displays winner-takes-all characteristics and where capital needs are usually low. Apple’s spending on plant, equipment and acquisitions has used up just 10-15 per cent of its operating cash flow in recent years. Even Google, at the peak of a spending surge three years ago that unnerved Wall Street, was investing little more than a third of its cash flow on building out its network.
Alongside the strong cash generation has been a habit of hoarding, caused partly by an innate conservatism in a sector where fortunes can reverse quickly. Steve Jobs, who had his own brush with bankruptcy, paid out nothing at all in dividends and buybacks, even though Apple generated $55bn in free cash flow in his final three years at the helm.
But as the cash mountains have grown, a second factor has assumed even greater significance. Due largely to tax avoidance strategies that have made it possible to book profits in low-tax countries, much of the tech cash is held offshore. Rather than return it to the US to pay dividends or fund buybacks and incurring an extra tax charge, most tech companies have preferred to wait – and lobby in Washington – for a tax holiday.
Some, such as Cisco, have purposely set out on a series of foreign acquisitions to use the cash in a tax-efficient way, though the scarcity of potential targets has limited its effectiveness.
This has left the tech companies looking increasingly constrained. Apple paid out $33bn to shareholders last year – and had the proportion of its cash sitting offshore jumped 8 percentage points, to 76 per cent. Microsoft, Oracle and Qualcomm have also had big increases: some 94 per cent of Microsoft’s $81bn is now outside the US.
Of non-financial companies in the S&P Global 1200 index, just 8.4 per cent hold 50 per cent of the cash
“Given many are cash rich, the attraction of cash proceeds from a sale of an asset is less attractive than a few years ago, as attractive alternative use of proceeds is increasingly an issue for the recipient,” says Mervyn Metcalf, of boutique investment bank Dean Street Advisors.
The embarrassment of riches has become a contentious issue on Wall Street. Applying a normal earnings multiple to the after-tax returns on cash produces much less in stock market value than the face value of the cash holdings, says Stuart Francis, head of technology banking at Barclays. As a result, he adds: “Excess cash can be a boat anchor on valuation.”
Even Apple has not been immune from the growing pressure, though activist Carl Icahn has reduced his call for the amount of cash to be returned to shareholders by two-thirds, to $50bn.
Even without direct pressure, more tech concerns have started to show a greater readiness to earmark their future profits for dividends or buybacks. In November, Qualcomm pledged that it would return three-quarters of its free cash flow to shareholders. Fellow chipmaker Texas Instruments went one better, saying earlier in the year that it hoped to distribute all of its free cash flow.
Caught between Wall Street pressure to distribute more of their money and the realities of the tax code, some have turned to borrowing to fund their cash needs. Last month, Microsoft led the way, adding to its existing $14bn of debt as it turned to the capital markets to borrow $8bn more.
With activist shareholders increasing their pressure on the most vulnerable, low-growth tech companies, there is likely to be considerably more debt coming, says Richard Lane, an analyst at Moody’s.
One result is likely to be a weakening of balance sheets across the industry. Chip company Altera was among the first to confront this, announcing last year that it would issue $1bn of debt – and promptly had two notches taken off its credit rating.
Yet for the biggest tech companies, there is still plenty of room for manoeuvre. Apple could raise another $20bn-$50bn in debt before its ratings come under pressure, according to Moody’s. That makes it likely that 2014 will be a year when both cash and debt levels soar in the tech world.
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