InvestmentsJul 30 2014

US corporate war chest ready and waiting

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One of the features of the US recovery from the financial crisis has been the growth in the cash piles among many of the corporates. Yes, we have seen some using their cash for rising dividends (American companies have never been so dividend orientated as their British cousins), and some even handing cash back to shareholders where they, quite responsibly, feel that they cannot find a better use for their shareholders’ monies.

Others have been buying their shares back (always a sign of a lack of imagination by management) – this has now reached an astonishing annualised rate of $400bn, which is the equivalent of 2.5 per cent of US GDP. The idea of the scheme, although sounding generous, is in fact to boost earnings per share and therefore enhance the value of executive share options – so not quite as generous as some would have you believe. What had been missing though was much sign of companies using their cash piles for reinvestment, or even mergers and acquisitions.

This as much as anything is a sign of lack of confidence and a general sense of risk aversion. As I have mentioned before this all seemed to change in January of this year when in that first month over $1bn of potential deals were announced. Since then it would seem that the levee has broken as the cash to carry out possible deals seems to have washed over the markets seeking new investment opportunities.

So where is this money to go? Well we can see from some figures that a good proportion is going on updating kit and replacing long delayed equipment, much of which will have gone past its normal operational life expectancy. For others though the prospect of buying up competitors is once again becoming quite appealing and has got the juices of the investment bankers started again. However, a subset of these companies have some other tax issues where overseas earnings would have a high tax penalty on them if they were to be repatriated to the USA, thus encouraging some other local investment. A classic example of this was of course Pfizer’s attempted bid for AstraZeneca.

Now according to Bank of America Merrill Lynch (BAML) this potential cash pile could be over $1.3tn and such financial firepower could be about to be turned on certain of our leading companies here. If you just run your finger down a list of UK (and come to that those continental) blue chips, then it is quite easy to answer the question “why not”?

From retailers like Tesco, to BAE Systems whose target for business has primarily been in the US defence market. Then we have engineering companies like AMEC, medical technology with Smith & Nephew, leading microchip developer ARM holdings and of course certain financial services companies. Remember that Asda was snapped up by Walmart. Now this is not just going to be a UK thing, as there are many more excellent businesses and brands across the EU that would be very attractive. However, as many have discovered before, hostile takeovers and sometimes even the seemingly amiable ones, are less of a feature on the continent. Target companies suddenly have an amazing ability to become state treasures or rather ‘strategic assets’ or in the case of Danone, the yoghurt maker ‘strategic defence assets’ – I always thought those fruit cornered yogurts were potentially lethal.

Of course we don’t seem to have that trouble in the UK as just about anything is for sale at the right price! This certainly is going to create a defensive line under many valuations as the possibilities of takeovers at premium prices are always very appealing to investors.

This may seem very flattering but strategically for Britain it would mean that even more of our companies could be losing their UK focus and base of management and leaving key investment decisions to management elsewhere in the world.

To the Americans you can also add some of the Chinese potential investors who have a similar problem investing their reserves in the US, and find the UK more open for such approaches especially in our infrastructure (although I don’t really put Weetabix into that category). However, they may take a different view if this island of ours parked off the North West coast of Europe decides to leave the largest trading bloc in the world.

Justin Urquhart Stewart is director and co-founder of Seven Investment Management.