In the early stages of the financial crisis, company managements went into survival mode and strived to de-lever their balance sheets, pay down and restructure debt back to more manageable levels, and in some cases, actually position themselves in a more positive cash position.
This strategy was aided by the fact that with major economies either in recession or growing slowly, there was significant spare capacity and therefore companies were not compelled to use large amounts of cashflow to fund capital expenditure (capex) programmes.
Show me the money
As stability returned and debt balances continued to improve, it was inevitable that shareholders and investors would want to know managements’ plans to use the increasing levels of cashflow that companies were generating. With limited growth opportunities there was no need to re-invest in the business − debt was at manageable levels − so the clarion call of shareholders became ‘give it back to us!’
As a result, we saw a substantial pick up in share buybacks. Companies that had never paid a dividend started to pay one and those that did pay dividends announced significant increases. Companies that followed this path had some of the best share price performances and this created a virtuous loop, encouraging more and more management teams to follow suit.
The seed for shareholders desire to see cash returned to them did not necessarily lie in a lack of belief in management’s discipline. Truth be told, with deposit rates and yields on government and corporate bonds being so low as they were, there was a genuine appetite for income and dividends.
So long as net debt levels were not problematic, company managements sought to keep investors happy with this diet of buybacks and dividends. With access to debt improved, there was a further development in this theme and with it a substantial pickup in debt issuance.
Bond markets
Companies who traditionally had not been active participants in the corporate bond markets, raised debt in increasingly larger deals. What made it all the more interesting was that in many cases these companies, like the technology giants of Microsoft, Apple, or Intel, were raising debt while at the same time having ample cash levels on their balance sheets.
Such was the demand from corporate bond investors − another bi-product of the search for yield globally − the interest rates paid by issuers were incredibly low and the maturity profile of the debt got exceedingly longer, in some cases all the way out to thirty years and beyond.
When companies announced these debt programmes they were also upfront about what the money raised was going to be used for − share repurchase programmes and special dividends.
All cash is not created equal
It is a fair question to ask that if these companies had so much cash on their balance sheets, why raise debt to fund these activities. Why not just use the cash?
The answer, particularly for the large US companies lies in where their cash was located. In accounting terms, when looking at a company’s balance sheet, the location of assets − be they buildings or in this case cash − is not an issue. The only thing that is important is that you own them. The problem is that tax authorities don’t share the same view.
Given the global nature of many of these companies and the favourable tax regimes of certain countries, much of their profit and cashflow is earned outside of the US.
In order to pay dividends or buyback shares, US companies need to have the funds in their domestic operations. But bringing cash in from overseas triggers a tax of 35% on those funds. Therefore, while credit markets were eager to lend money at attractive rates, managements saw little sense in paying the ‘unnecessary’ taxes associated with repatriating cash to return to shareholders.