LDN - Business

Cash conundrum has investors clamoring for capital ideas

[May 03, 2018] By Sinead Cruise and Simon Jessop

LONDON (Reuters) - Splashing corporate cash may be in vogue, with bumper share buybacks and record takeovers, but some investors are demanding firms spend more on improving assets they already own.

Of nearly a dozen fund managers contacted by Reuters, three-quarters expressed concern about the way companies are allocating capital during a period of relatively healthy cashflow.

"If you are in boom times, by and large capital tends to be allocated poorly," Ben Whitmore, manager of the Jupiter Special Situations Fund, said.

After a nine-year bull run in stock markets, many analysts consider British and European companies to be close to peak values, ramping up the risk of over-priced purchases.

"There's been record volumes of M&A recently and there's bound to be some complete howlers in that. Time will show what they are," Whitmore added.

Globally deals totaling $1.55 trillion have been struck so far this year, while in Europe mergers and acquisitions (M&A) have totaled more than $621 billion, up 151 percent on the same period in 2017, Thomson Reuters data shows.

Global cash-only M&A: https://reut.rs/2rfPadA

The aggregated value of cash only takeovers so far in 2018 has risen by 33 percent year-on-year while the value of deals using cash and stock has risen by 221 percent, as companies look to exploit their buoyant share valuations.

"A lot of M&A actually destroys value for shareholders, not adds value ... acquisitions are quite risky, they can be distracting, they have to be integrated effectively," Sue Noffke, fund manager at Schroders <SDR.L> said.

Meanwhile, companies have spent or committed to spend hundreds of billions of dollars on repurchasing stock so far this year, with Apple Inc <AAPL.O> alone planning to buy back up to $100 billion of its shares in an effort to bolster its returns.

By contrast, the latest Global Corporate Capital Expenditure Survey from Standard & Poors showed that the top 20 capex spenders among non-financial companies in Western Europe invested just shy of $200 billion in aggregate in 2016.

And across Europe, the Middle East and Africa, companies had stashed 974 billion euros of cash by the end of 2016, the latest data from Moody's Investor Service showed, with the ratio of cash relative to revenue at a seven-year high.

That has in part been fueled by ultra cheap debt, an era which is expected to come to an end as central banks around the world gradually tighten the loose monetary policy used to see wobbling economies through the financial crisis.

"What we don't want is for companies to gear up balance sheets ... we do want them to use spare cash to invest in their businesses," David Keir, co-manager of the Saracen Global Income & Growth Fund, told Reuters.

S&P data shows the non-financial companies in its rating universe grew capex by just 7 percent in the last 12 months, despite posting sales growth and EBITDA growth of 13.6 percent and 15.2 percent respectively over the same period.

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U.S. one dollar bills blow near the Andalusian capital of Seville in this photo illustration taken on November 16, 2014. REUTERS/Marcelo Del Pozo

However, there are indications some companies appear to be listening, or at least questioning whether copy-cat M&A deals will deliver their growth ambitions. Analysts at UBS said a net 30 percent of corporate respondents to its Evidence Lab Survey said they expected to increase capex over the next year.

"We're wary of M&A deals, full-stop. Particularly companies going out to find deals because they feel that they are under pressure to do something," Andrew Cave, Head of Governance & Sustainability at Baillie Gifford, said.

While some companies have been caught on the M&A escalator, others have won plaudits for stepping off.

Charlie Huggins, manager of the HL Select UK Income Shares fund, which holds a position in GlaxoSmithKline <GSK.L>, cheered the British drugmaker's recent decision to abandon a bid for Pfizer's <PFE.N> Consumer Health business.

"The key priority now is extending this capital allocation focus to the R&D pipeline," he said, adding it was "critical in getting investors back on side in the long run".

BYE-BYE BUYBACKS

Corporate America has led the way in passing on the problem of its surplus capital to investors via share repurchases, with around $530 billion spent on U.S. buybacks last year and $800 billion expected in 2018, according to JPMorgan.

Critics decry a lack of ambition and ideas among company executives, most of whom have long-term incentive plans linked to the price of their shares, which are lifted by buybacks.

Even special dividends are beginning to lose their luster, the fund managers said, particularly when viewed in the context of paltry organic investment figures.

George Godber, fund manager at Polar Capital, said doubts over how executives deployed their funds was a key reason why he was steering clear of many of Europe's largest companies.

"We are seeing a lot of poor use of capital - too much in dividends and too much in buybacks. We're very, very supportive if they've got sensible M&A to do but the actual grunt of integrating complex transactions can be really tough," he said.

Calls on executives to use capital more constructively could yet have a bearing on a number of deals in the pipeline, particularly if shareholders withdraw support in favor of more organic investment, the investors said.

"The market has rewarded solid, predictable earnings growth for the last 8 or 9 years. And clearly M&A comes with elevated risk," Old Mutual Global Investors fund manager Ed Meier said.

"You need very strong management teams who are confident in their ability to structure deals, but also execute quickly on these deals. And it's a skillset that isn't available to all."

(Editing by Alexander Smith)

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