The Inoculated InvestorWest Coast Asset Management

Give Us Back Our Cash!

What if I told you that Cisco now has $39.1 billion in cash on its balance sheet versus only $12.1 billion indebt? What if you found out that Google and Apple had cash stockpiles of $30.1 billion and $24.3 billion,respectively, and were both debt free as of their most recent filings? You would not be alone if you feltshocked that they were holding so much cash that yields next to nothing. Unfortunately, those previousfigures are completely accurate.

According to Standard and Poor’s (S&P), US non-financial companies inthe S&P 500 are holding $837 billion (up from $665 billion a year ago; a 25.8% increase) in cash.

Manystock market commentators immediately take this cash hoarding to be a very bullish sign because theyassume that the cash will eventually be deployed to fund R&D, share buybacks, dividend increases andmost importantly, mergers and acquisitions.Additionally, Wall Street analysts aredrooling over the consolidation this cash willfacilitate in industries from pharmaceuticalsto energy companies. But, let us makesomething very clear: the fact that somecompanies are carrying so much cash ontheir balance sheets is unfair to shareholders.Let’s review why companies may berationally hoarding cash but also highlightwhy these reasons should be causes for concern for shareholders:

Regulatory and fiscal uncertainty:FinReg. ObamaCare. Cap & Trade.Offshore drilling moratoriums.Bush tax cut expiration. Putyourself in the shoes of a CEO inAmerica and you will soon realizethat the lack of clarity surroundingthe previously mentioned items hasadded an incredible amount of uncertainty to economic fundamentals of just about every industry. Without much contemplationyou start to come up with a list of questions for which the ultimate answers could have asignificant impact on US companies. Are the Bush tax cuts going to expire and push up corporateincome tax rates? Is ObamaCare going to increase the cost of providing health insurance toemployees? Could the passage of cap and trade legislation cause a spike in the cost of energy?What would a prolonged offshore drilling moratorium do to the economy of the states located near the Gulf of Mexico? Could the FinReg bill limit the amount of credit banks will be able to provideto businesses?The problem, of course, is that there is no way to know the answers to these questions. But, nomatter the type of company, the industry, or number of employees, these issues need to beresolved before CEOs and managers feel comfortable making investments in their companies.Accordingly, many firms will continue to hold cash until they know how to plan for the future.Unfortunately, this means that investors can expect minimal discretionary capital expenditures,dividend increases or share buybacks until companies are more comfortable. Specifically,companies will be reluctant to allocate capital until they are less afraid that our leaders inWashington will not cause future harm to businesses through their seemingly capricious policies.But worst of all, this widespread uncertainty just about guarantees that companies will be cautiouswhen it comes to hiring new employees, a circumstance that will likely contribute to a long periodof uncomfortably high unemployment.

Company NameCash & Short TermInvestments($US billions)Long Term Debt($US billions)

General Electric$116.0 $489.7Cisco$39.1 $12.1Microsoft$36.7 $4.9Ford Motor$34.7 $32.3Google$30.1 $0.0Berkshire Hathaway$25.7 $55.6Apple$24.3 $0.0WellPoint$20.2 $7.3Oracle$18.5 $11.5Intel$18.3 $2.1Johnson & Johnson$18.0 $8.5Pfizer$17.3 $38.3Hewlett-Packard$14.2 $13.7Amgen$14.5 $9.3ExxonMobil$13.8 $7.1IBM$12.2 $21.0

The Inoculated InvestorWest Coast Asset Management

A return to panic The takeaway by CEOs of the aftermath of the worst parts of the financial crisiswas that the global economy can fall off a cliff at a moment’s notice. Specifically, after LehmanBrothers failed the financial markets seized up and caused worldwide commerce to basically shutdown. Furthermore, interest spreads blew out, counterparties stopped trusting one another, andcompanies ceased making capital expenditures and purchasing new inventory. With the imprint of that traumatic period still in the minds of American business leaders, it makes sense that they wantto hold cash as a hedge against unforeseen events. Some companies such as Berkshire Hathawaywant to have dry powder in case the valuations of potential acquisitions drop dramatically.However, the majority of companies likely see cash as the only asset that can guarantee flexibilityand solvency in stressed economic times. Regrettably, this situation brings to mind John MaynardKeynes’s Paradox of Thrift which said that while it is prudent for an individual to cease spendingand save during uncertain times, when everyone does so then aggregate demand falls andeconomic growth suffers. In other words, the fact that so many companies are building cashreserves instead of spending and investing serves to hamper the nascent (and tenuous) economicrecovery.

Fear of debt: The other takeaway from the turmoil inthe financial markets in late 2008 and early 2009 was,as Warren Buffett has so eloquently stated, companiesnever want to be dependent on the kindness of strangers. These strangers who The Oracle of Omahawas referencing are providers of capital for companiesand specifically potential purchasers of debt. When thedebt markets completely froze after Lehman wentdown, many levered companies were completely lockedout of raising debt. Even very credit worthy companieswere forced to pay rates that did not reflect the strengthof their business models and cash flows. Additionally,any company which analysts and investors felt was atrisk of not being able to meet a debt maturity saw itsstock price decimated by scared sellers fleeing thestock. Accordingly, whether their fears turn out to be prescient or not, it is completely logical for business managers to hold cash in order to make sure they do not have to tap the credit markets atinopportune times or risk a large stock decline due to concerns over debt repayment.

The repatriation problem: According to US accounting rules, if companies deem that cashgenerated outside the US will remain there permanently, they do not have to pay taxes on thatamount. However, if companies decide to bring that cash back into the US, they often have to paythe full 35% corporate tax rate on the amount transferred. That is an incredibly steep penalty to pay for companies that want to make domestic investments that create jobs, buy domesticcompanies and pay dividends. Just last month, Cisco CEO John Chambers publicly advocatedloosening the rules on repatriation so that his company could bring back some of the $30 billion incash it currently holds overseas.

Unfortunately, such forbearance does not currently appear to beon policy makers’ agenda. As such, even if companies wanted to spend some of their overseascash in the US or return some of it to shareholders, the tax is so prohibitive that it is unlikely toreturn home anytime soon. Now that we have established that companies’ desire to keep a lot of cash on hand is logical and maybeeven prudent in some cases, the question arises of what should shareholders do? The reason some kind of action may be warranted is that companies are earning negative inflation adjusted returns on their cash. Infact, they are likely not receiving any better yields than individual investors can on their own. At the end of the day that cash belongs to shareholders but we entrust it to management with the hope that it will beallocated in a way that maximizes return. Clearly that is not happening today and, as a result, earnings,employment opportunities, and economic activity are being negatively impacted. The truth is that, as