Dash for the Cash

One of the bigger business stories of 2010 was the fact that throughout the year, corporations large and small were hoarding their cash.

I'm referring specifically to non-financial companies, whose balance sheets were generally in decent shape entering the year.

As 2010 progressed, many companies recorded strong profits, driven mostly by cost savings (read: reduced headcount), generating healthy operating cash flow in the process.

However, given the lingering uncertainty in the economy, including the perceived threat of a double-dip recession, most companies held on to their cash, eschewing such cash-utilizing activities as dividend payouts, stock repurchases and capital investments. Companies aren't simply deleveraging either; aided by historically low interest rates and more favorable yield spreads, large, credit-worthy corporations stocked up on inexpensive debt in 2010 as well.

This resulted in some extremely cash-rich balance sheets. According to the Wall Street Journal, the aggregate amount of cash on corporate balance sheets amounted to approximately $1.93 trillion as of September 30, 2010, up about 6% from June 30, 2010, and substantially higher than one year earlier. According to the Federal Reserve, cash and equivalents amounted to 20% of total assets on the aggregate corporate balance sheet, the highest level since 1959. While there are several factors which play into that last statistic, it became quite clear throughout the year that companies in the U.S. are holding on to their cash.

Looking ahead, I think that this situation will give rise to what I expect to be one of the major U.S. business trends of 2011, the hostile takeover.

As in the 1980's when hostile takeovers were very popular, companies sitting on lots of cash will be targeted by other companies, many of whom boast relatively high stock prices. The stock market is up nearly 40% since the end of 2008, giving many companies richly valued currency with which to do deals. Buying a company with a large cash balance introduces a risk-free return element to any deal, lowering the effective cost of the transaction, thereby improving the effective return on investment (ROI). Add to that the fact that benchmark interest rates are still extremely low, reducing a company's cost of capital (and in return, its "hurdle rate"), and the idea of doing acquisitions, friendly or otherwise, becomes even more attractive. In other words, with a dearth of high-return options available (consider what you are getting on your money market accounts in the bank), buying another company becomes that much more viable an option.

All in all, it would make for a very interesting merger-and-acquisition landscape in 2011. I'm not sure if the purchasers will be strategic (a company in the same or a related industry) or financial (a private equity or buyout firm), but companies who refrain from investing their cash today might find those investment decisions in someone else's hands tomorrow.