Scaling the Mountain: Will Corporates put Unspent Cash to Work?

Are the chances of a sustained global economic recovery being undermined by companies’ aversion to spending or investing? What could be done to encourage a corporate spending revival?

The bulk of the growing ‘cash mountain’ – conjuring images of Scrooge McDuck – resides chiefly among US technology and IT multinationals, including Google, Microsoft, Oracle and Apple.

Apple’s cash reserves, approaching US$160bn, equate to the greatest unallocated capital stockpile among US corporates ahead of Microsoft (nearing US$90bn), Google (close to US$60bn) and Oracle (US$37bn). Much of these funds are held offshore for ‘tax minimisation’ reasons, totalling close to US$2 trillion abroad.

Greater emphasis on regulation, stringent compliance procedures and crisis prevention protocols is reflected in shorter dated performance ratings and sales expectations among boardrooms the world over.

Hallmarks of an improving economy such as expanding productive capacity, rising wages and reduced unemployment have certainly not been broadly observed to the extent that policy makers would be content with.

Wage freezes, outsourcing, cost minimisation and offshoring remain firmly in place, long after capital markets suffered their biggest shock since the Great Depression. Liquidity is back, yet interest rates remain locked at historic lows due to a fundamental behavioural alteration by businesses in their approach to sourcing and servicing of debt.

Greater credence is given to saving over investing across Europe, Asia and the US as monetary authorities are forced to keep real interest rates down. Resource and energy companies contribute the most to global capital expenditure (capex), highlighting a growing concern over sluggish growth problems and rising debt obligations that has afflicted emerging markets (EMs) in recent months.

Higher extraction costs have also caused significant difficulties in terms of cost-benefit valuations for new projects, exacerbating the already significant capital expenditure (capex) allocation obstruction.

Smaller Businesses Lead Borrowing

Reserve Bank of Australia (RBA) governor Glen Stevens recognises the fact that the onus for generating a new stage of economic growth should not fall on business managers alone “out of a public-spirited desire to help the economy”.

Although it is arguably in businesses’ own best interest to begin investing more in their own operations as the Australian economy rotates away from resources investment, the extent to which chief financial officers (CFOs) and treasurers put excess cash reserves to work will significantly impact the rate of future economic growth to an ever-growing extent. The RBA has actively encouraged Australian businesses to redevelop their ‘animal spirits’ in the form of calculated risks and a move away from record dividend payouts in order to keep the economy ticking over.

East & Partners’ deposit funding and debt index (DFDI), structured by overlaying the firm’s demand side segmentation over monthly Australian Prudential Regulatory Authority (APRA) banking statistics, indicates that Australian borrowing demand is now driven from the ‘bottom-up’. Institutional sized businesses, constituting the top 500 enterprises by turnover, now deposit more than they borrow from the banking system for the first time since DFDI reporting began in 2010.

The institutional deposits-to-borrowing ratio has increased exponentially as aggressive deleveraging and a rotation away from borrowing for new acquisitions is predicted to remain the norm throughout the final months of 2014. Australian banks’ business credit growth rose to roughly 5% in June 2014 – the highest rate in two years – underpinned significantly by small and medium enterprises’ (SMEs) and corporates’ resurgent credit appetite.

Supported by greenfield capital expenditure (capex) demand for several years, the Australian economy’s dependence on the mining sector now presents itself as a stark example of how quickly the economy has shifted into a state of transition as cost cutting and efficiency motivators take centre stage.

SMEs are actively re-engaging their loan book to take advantage of historically low interest rates and uplifting business sentiment in non-mining related sectors. The SME DFDI ratio has now fallen over the past two years, from a June 2012 high of 2.62 to a new record low of 0.96. Small businesses are now borrowing more from the banking system than they deposit for the first time in over four years; however what proportion of these funds is flowing towards investments in greater productive capacity?

The Aim of Abenomics

Japan’s prime minister Shinzo Abe has also stated a clear mandate for its companies to stand up and deliver more for the country-wide economic revival. Squirreling away short-term profits delivered on the back of loose monetary policy and a relatively depreciated yen is hampering ‘Abenomics’ overall success.

The Bank of Japan (BoJ) asserts that the impact on the Japanese economy of a
sales tax hike
from 5% percent to 8% in April this year has been minimal, yet a further quarterly gross domestic product (GDP) contraction in Q214 of 1.8% places further pressure on the Japanese government to expand stimulus in the absence of sufficient corporate capex.

Aversions to greater spending and investment by corporates include a lack of incentives for capital intensive research and development, tax treatment of repatriated offshore funds, potential future healthcare costs and an aging population whose demands ‘small government’ will not be in a position to accommodate for in years to come.

Instead of investing in new assets and capital, CFOs are pursuing extended machinery and plant lives, effectively favouring re-pricing over replacement to the detriment of broader economic growth.

An expectation that low interest rates will not remain in place in perpetuity has resulted in greater usage of cheap, revolving credit for business operations, instead of the desired application to capex or paying down of existing debt.

Greater corporate capital expenditure is viewed as a vital component of continued global economic stability; however several major impediments remain in place to putting veritable piles of cash to work. The RBA’s Glen Stevens openly admits that it is ambitious to expect low interest rates alone to automatically spur higher spending and borrowing.

Excess cash reserves are traditionally reallocated by reinvesting in the business itself, mergers, acquisitions and hostile takeovers or returning capital to investors in the form of share buybacks and higher dividends.

Corporate actions represent the majority of capital allocation priorities currently, and despite mergers and acquisitions (M&As) as a share of market capitalisation remaining lower than the levels reached over a decade ago, a boom is widely expected to take place in the next six to twelve months.

International M&A activity now exceeds US$885bn as the hunt for yield heats up; however one of the primary motivating factors remains cost reductions as opposed to improved productivity or access to new markets.

Investors are increasingly airing their concerns about underinvestment in longer-dated productive capacity, clearly desiring the concerted deployment of abundant cash reserves towards sustainable, productive future capital allocations.

Lessons learnt from the 2007-09 global financial crisis are clearly not long forgotten as mountains of underutilised corporate cash grow higher, seemingly to the detriment of continued economic stability and growth across the globe.

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