The Inoculated Investor West Coast Asset Management

Give Us Back Our Cash!

What if I told you that Cisco now has $39.1 billion in cash on its balance sheet versus only $12.1 billion in
debt? What if you found out that Google and Apple had cash stockpiles of $30.1 billion and $24.3 billion,
respectively, and were both debt free as of their most recent filings? You would not be alone if you felt
shocked that they were holding so much cash that yields next to nothing. Unfortunately, those previous
figures are completely accurate.1 According to Standard and Poor’s (S&P), US non-financial companies in
the S&P 500 are holding $837 billion (up from $665 billion a year ago; a 25.8% increase) in cash.1 Many
stock market commentators immediately take this cash hoarding to be a very bullish sign because they
assume that the cash will eventually be deployed to fund R&D, share buybacks, dividend increases and
most importantly, mergers and acquisitions.

Additionally, Wall Street analysts are Cash & Short Term

drooling over the consolidation this cash will Investments Long Term Debt
Company Name ($US billions) ($US billions)
facilitate in industries from pharmaceuticals
to energy companies. But, let us make General Electric $116.0 $489.7
something very clear: the fact that some Cisco $39.1 $12.1
companies are carrying so much cash on Microsoft $36.7 $4.9
their balance sheets is unfair to shareholders. Ford Motor $34.7 $32.3
Google $30.1 $0.0
Let’s review why companies may be
Berkshire Hathaway $25.7 $55.6
rationally hoarding cash but also highlight
Apple $24.3 $0.0
why these reasons should be causes for
concern for shareholders: WellPoint $20.2 $7.3
Oracle $18.5 $11.5
1. Regulatory and fiscal uncertainty: Intel $18.3 $2.1
FinReg. ObamaCare. Cap & Trade. Johnson & Johnson $18.0 $8.5
Offshore drilling moratoriums. Pfizer $17.3 $38.3
Bush tax cut expiration. Put
Hewlett-Packard $14.2 $13.7
yourself in the shoes of a CEO in
Amgen $14.5 $9.3
America and you will soon realize
that the lack of clarity surrounding ExxonMobil $13.8 $7.1
the previously mentioned items has IBM $12.2 $21.0
added an incredible amount of
uncertainty to economic fundamentals of just about every industry. Without much contemplation
you start to come up with a list of questions for which the ultimate answers could have a
significant impact on US companies. Are the Bush tax cuts going to expire and push up corporate
income tax rates? Is ObamaCare going to increase the cost of providing health insurance to
employees? Could the passage of cap and trade legislation cause a spike in the cost of energy?
What would a prolonged offshore drilling moratorium do to the economy of the states located near
the Gulf of Mexico? Could the FinReg bill limit the amount of credit banks will be able to provide
to businesses?

The problem, of course, is that there is no way to know the answers to these questions. But, no
matter the type of company, the industry, or number of employees, these issues need to be
resolved before CEOs and managers feel comfortable making investments in their companies.
Accordingly, many firms will continue to hold cash until they know how to plan for the future.
Unfortunately, this means that investors can expect minimal discretionary capital expenditures,
dividend increases or share buybacks until companies are more comfortable. Specifically,
companies will be reluctant to allocate capital until they are less afraid that our leaders in
Washington will not cause future harm to businesses through their seemingly capricious policies.
But worst of all, this widespread uncertainty just about guarantees that companies will be cautious
when it comes to hiring new employees, a circumstance that will likely contribute to a long period
of uncomfortably high unemployment.
The Inoculated Investor West Coast Asset Management

2. A return to panic The takeaway by CEOs of the aftermath of the worst parts of the financial crisis
was that the global economy can fall off a cliff at a moment’s notice. Specifically, after Lehman
Brothers failed the financial markets seized up and caused worldwide commerce to basically shut
down. Furthermore, interest spreads blew out, counterparties stopped trusting one another, and
companies ceased making capital expenditures and purchasing new inventory. With the imprint of
that traumatic period still in the minds of American business leaders, it makes sense that they want
to hold cash as a hedge against unforeseen events. Some companies such as Berkshire Hathaway
want to have dry powder in case the valuations of potential acquisitions drop dramatically.

However, the majority of companies likely see cash as the only asset that can guarantee flexibility
and solvency in stressed economic times. Regrettably, this situation brings to mind John Maynard
Keynes’s Paradox of Thrift which said that while it is prudent for an individual to cease spending
and save during uncertain times, when everyone does so then aggregate demand falls and
economic growth suffers. In other words, the fact that so many companies are building cash
reserves instead of spending and investing serves to hamper the nascent (and tenuous) economic
recovery.

3. Fear of debt: The other takeaway from the turmoil in

the financial markets in late 2008 and early 2009 was,
as Warren Buffett has so eloquently stated, companies
never want to be dependent on the kindness of
strangers. These strangers who The Oracle of Omaha
was referencing are providers of capital for companies
and specifically potential purchasers of debt. When the
debt markets completely froze after Lehman went
down, many levered companies were completely locked
out of raising debt. Even very credit worthy companies
were forced to pay rates that did not reflect the strength
of their business models and cash flows. Additionally,
any company which analysts and investors felt was at
risk of not being able to meet a debt maturity saw its
stock price decimated by scared sellers fleeing the
stock. Accordingly, whether their fears turn out to be prescient or not, it is completely logical for
business managers to hold cash in order to make sure they do not have to tap the credit markets at
inopportune times or risk a large stock decline due to concerns over debt repayment.

4. The repatriation problem: According to US accounting rules, if companies deem that cash
generated outside the US will remain there permanently, they do not have to pay taxes on that
amount. However, if companies decide to bring that cash back into the US, they often have to pay
the full 35% corporate tax rate on the amount transferred. That is an incredibly steep penalty to
pay for companies that want to make domestic investments that create jobs, buy domestic
companies and pay dividends. Just last month, Cisco CEO John Chambers publicly advocated
loosening the rules on repatriation so that his company could bring back some of the $30 billion in
cash it currently holds overseas.2 Unfortunately, such forbearance does not currently appear to be
on policy makers’ agenda. As such, even if companies wanted to spend some of their overseas
cash in the US or return some of it to shareholders, the tax is so prohibitive that it is unlikely to
return home anytime soon.

Now that we have established that companies’ desire to keep a lot of cash on hand is logical and maybe
even prudent in some cases, the question arises of what should shareholders do? The reason some kind of
action may be warranted is that companies are earning negative inflation adjusted returns on their cash. In
fact, they are likely not receiving any better yields than individual investors can on their own. At the end of
the day that cash belongs to shareholders but we entrust it to management with the hope that it will be
allocated in a way that maximizes return. Clearly that is not happening today and, as a result, earnings,
employment opportunities, and economic activity are being negatively impacted. The truth is that, as
The Inoculated Investor West Coast Asset Management

investors, it is our decision whether or not to hold cash in our investment portfolios. We do not buy shares
of Cisco so that John Chambers can manage our cash for us and should not pay for Google to establish a
bond desk just to pick up some incremental yield. We want these companies to make investments in their
businesses that generate returns which are not available to us otherwise.
Accordingly, while we understand why companies have decided to hold so
much cash, we think the pendulum has swung too far for some companies.
Management teams have become too conservative and cautious and it is
hurting returns and hurting the US economy.

Having said that, despite the huge cash balance, companies like GE should
not be focused on rewarding shareholders. Instead, one simple and
effective solution is for companies with steady cash flows and minimal
leverage to return the cash to shareholders in the form of share buybacks
and dividends. It is obviously undesirable for firms to use cash that has to
be repatriated, but unless companies have M&A opportunities that are
already in the pipeline, they should put US-generated cash back in the hands
of shareholders so that we can make our own decisions on how to manage
it. In addition, for those companies with a significant amount of leverage and whose large cash balances
stem from recent debt issuance, our desire is for them to pay down more expensive debt in order to de-
lever. In summary, we want companies to do something with the cash that is in the long term interest of
shareholders as opposed to letting it languish on their balance sheets.

References:
1. Sources: http://www.usatoday.com/money/companies/2010-07-28-cashcows28_ST_N.htm and
Capital IQ
2. http://www.foxbusiness.com/story/markets/industries/telecom/cisco-ceo-urges-loosen-tax-terms-
cash-repatriation/
3. First picture courtesy of: not-normal-media.co.uk
4. Second picture courtesy of http://www.sbcounty.gov/