Cash tsunami coming to the US
One of the expectations of the incoming Trump administration is that it will implement a significant corporate tax overhaul that will unleash a ‘cash tsunami’ across corporate America.
The anticipated tax overhaul is expected to include a tax holiday to repatriate overseas cash at a one-time rate of 10 percent, and lower the corporate tax rate from 35 percent to 15 percent. Among S&P 500 companies, it is estimated that approximately $200 bn of the approximately $1 tn of cash held outside the US could be repatriated in 2017.
The reality of this tsunami creates an immediate need for management teams and boards to carefully consider what investors, competitors and other stakeholders expect from this cash wave. The importance of a solid capital allocation plan and corresponding communications strategy cannot be understated.
Will investors trust you to spend cash on Capex? What about M&A in a market with record valuations? Will competitors gain a balance sheet advantage? Will you be targeted by a hostile bid or an unwanted campaign by an activist investor?
There are three reasons this is an urgent issue for boards and management teams to address:
1. The cash tsunami will be uneven: some companies will benefit more than others. The complexity and timing will create a high risk for misconceptions
2. Capital allocation disclosure is inadequate. One telling example of this is that over the past year, the majority of S&P 500 companies did not expound on capital allocation plans in their investor slides, and even fewer do it prospectively
3. The modern shareholder base, mixed with passive funds and activist investors, leads to a direct focus on capital allocation decisions with meaningful implications for the future of the company.
It’s an old adage but, in general, investors do not trust issuers with excess cash. One misstep is what they remember. A botched acquisition, failed factory expansion or missed product launch can taint management’s reputation and drive down valuations. Moreover, conflicting opinions among investors are easy to find. One shareholder may advocate a dividend, while another prefers a share buyback and still another wants greater investment in the business.
Investor disagreement on what is best has perhaps left companies a bit frozen when it comes to disclosure. Companies often leave investors in the dark on capital allocation. In our view, capital allocation should be central to the investor story.
Over the past year, only 136 companies – or 27 percent of the S&P 500 – mentioned the phrase ‘capital allocation’ in their investor slides, according to data from FactSet. And when we looked at other phrases like ‘capital management’ and ‘capital discipline’ the numbers only got worse – 13 percent and 5 percent, respectively.
The companies that did mention their capital allocation plans often did so in the context of past – not future – performance (such as a check-the-box line like ‘our capital allocation plan included $50 million in shareholder buybacks…’).
While presentations are certainly not the only form of disclosure an investor can use to gather information on capital allocation, they are an important marker to consider how capital allocation currently features with investors. Indeed, perhaps one reason investors are often unsatisfied with a company’s capital management is that they frequently don’t know what to expect.
Modern shareholders, modern priorities
Investors may not trust issuers with cash, but a revolution in the issuer-investor relationship is adding a new wrinkle to the traditional dynamic.
The first concern is the rise of shareholder activism, where cash is a central part of the activist screen and often a key focus of an overarching campaign. In fact, an emphasis on returning cash to shareholders was a central point of contention in 73 – or 19 percent – of the campaigns in 2015.
Then there is the massive rise in passive funds that must be considered in understanding the modern shareholder dynamic. Just three firms – BlackRock, State Street and Capital Group – own between 10 percent and 20 percent of most US companies in aggregate, according to The Economist. Vanguard alone owns an astounding 5 percent in 468 of the companies in the S&P 500, reveals the Wall Street Journal.
These firms have become increasingly vocal about making long-term growth a priority and they consider the clear articulation of capital allocation strategies to be a foundational building block of good corporate governance that is tied to value creation.
Make the capital story a priority
Effective communications can help a company win support from influential long-term investors to pursue a clear strategy and even fend off unwanted offers or other actions. Furthermore, in a highly volatile political environment, well-articulated plans and principles can reduce the likelihood of becoming a target.
Here’s our take on what management teams and boards should be doing:
1. Clarify your strategy. Refine your long-term value proposition and messaging, and consider how capital allocation supports the long-term value story
2. Look forward. Articulate the rationale behind capital deployment moving forward. Expound on the ‘why, how and when’, not just the ‘what’. Many companies that have improved communication around capital allocation have done so only after an activist investor has demanded change. Companies should work to improve their capital allocation communications before an activist shows up in their stock
3. Repeat. Make the capital story a key part of your investor narrative. Include a slide or two in your core investor materials. Talk about it in media interviews. Put it into earnings announcements.
In an era defined by unpredictability, it’s clear the cash tsunami in some form is coming. Be prepared and stay ahead of it so that it doesn’t overwhelm you and sweep you out to sea.
Kensey Biggs is senior vice president and Patrick Tucker is executive vice president at corporate, strategic and financial communications consultancy Abernathy MacGregor