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This article was originally printed in
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Bank of Canada Governor Mark Carney awakened Corporate Canada from its summer slumber in late August with his observation that Canadian companies were being overcautious and hoarding excessive amounts of cash — which he referred to as “dead money.” Carney’s proposed solution was for Canada’s titans of industry to either invest the money or return it to shareholders, who could then decide what to do with it. The comments ignited a wave of reaction (and finger pointing) from chief executives, economists and policy analysts.
Two months later, the issue of dead money persists, and the media continue to debate the validity of Carney’s comments — whether there’s merit, for instance, in holding reserves in a gloomy economy; whether tax incentives should play a greater role in boosting corporate spending; and whether the presumed cash cushion held by offending corporations even exists. At the same time, a number of significant share buybacks (typically in the form of normal course issuer bids) were announced or extended during the period subsequent to Carney’s criticism. These share buybacks – from companies like CN, Tim Horton’s, Celestica, Rogers, QLT and Agrium – may lend support to the notion of dead money.
In addition to its relevance for strategic planning and economic policy, the concept of dead money has implications for the measurement of business value. In the world of notional business valuation, where Chartered Business Valuators provide determinations of fair market value to help settle legal disputes, support fairness opinions, evaluate strategic options and comply with securities and tax laws, the issue of excess cash presents itself in several contexts.
A determination of business value typically involves, among other things, an analysis of a company’s optimal capital structure (i.e., the mix of debt and equity used to finance operations), as well as benchmarking the subject company’s risk and return profile against alternative investments. The valuator also needs to be concerned with the distinction between operating assets and non-operating assets. Ultimately, a share valuation indicates the value of business operations, often referred to as enterprise value, to which is added the value of non-operating (often referred to as “redundant”) assets, such as excess cash, less debt.
Equity investors purchase shares in order to receive a suitable rate of return relative to the perceived investment risk. Cash in company coffers that is not earmarked for sustaining or growing cash flow from operations earns a relatively low rate of return in today’s low-interest environment. This in turn drags down the overall rate of return on the investment. Excess cash does not enhance the value of operations of a business, and for this reason is referred to in the valuation world as a redundant asset.
It has been argued, however, that so-called “dead money” can serve useful functions, such as insulating against a credit scarcity as seen in the last financial crisis or providing a war chest for strategic acquisitions. Overall, proponents of holding “dead money” believe that excess cash reduces operating risk. But holding redundant assets will inevitably lead investors to ask a series of pointed questions. Why is there excess cash in the business in the first place? Why are there no plans to make strategic use of the cash? And how can the cash be converted into productivity gains?
From a business-valuation perspective, however, the questions relate to the amount of cash actually needed for ongoing operations, the amount of cash needed for expansion, and how the capital structure, capital-expenditure plans and working-capital needs compare to peer benchmarks. In addition, there may be requirements for what would otherwise be seen as excess cash, such as the need to satisfy lending covenants, regulatory requirements, or to cover seasonality or cyclicality of the subject business.
While holding excess cash may not enhance the value of a company’s business operations, in an uncertain economy, it can, admittedly, provide a cushion to enable a soft landing. If our government does not motivate the active deployment of excess cash through tax incentives or rate cuts, which potentially could enhance value through productivity gains or growth, it will be up to investors to decide whether they will reward corporations for keeping cash or punish them for not deploying it or returning it.
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