What's the next big thing on the corporate governance front? Smart investors will begin to use the shareholder proposal process to hold directors' feet to the fire on the company's cost of capital and their stewardship of the company's stash of shareholders' cash — insisting that they manage it as a truly “prudent person” would.
Here's why we believe this, and why we think such actions are way overdue.
U.S. public companies are currently sitting on $2 trillion in their treasuries — a record-breaking and truly staggering amount of cash. These monies legally belong to shareholders. So what have companies been doing with these funds?
Over the past decade, and now, once again, as the economy slowly recovers, many of our biggest and best-known companies have been earmarking the lion's share of free cash to stock buyback programs. And these programs, it must be noted, have had historically horrible results. A recent Morgan Stanley study of buybacks at 26 industrial companies since 2007 found that more than half had a zero or negative return.
Turn for a second to the tens of billions U.S. banks spent to buy back shares between 2000 and 2007. All of this cash could, in theory, have gone directly to shareowners. But all of it went up in smoke instead — never to be seen again — in the financial crash. And now, big banks are once again allocating the lion's share of their free cash to buybacks rather than to dividends. JP Morgan Chase, for example, recently announced it would increase the annual dividend payment by $3 billion, and buy back $8 billion in stock. At Wells Fargo, the board authorized a $1.5 billion dividend increase, and a buyback program that could go as high as $6 billion.
How did they come up with these ratios for cash outlays? And what is the expected return to shareowners on these “investments” of their cash? If one is a long-term investor, one ought to be asking questions like this and, we say, demanding answers.
Our own pet peeve here is describing buybacks as “returning money to investors” — a perversion of English, and of logic, that comes close to being fraudulent language in our book. If we want to cash out, we can simply call our broker, or go on E-Trade.
Bad as all these misguided buybacks are, there is worse news when it comes to corporate use of free cash to make acquisitions. As data from McKinsey & Co. again affirmed this past June, roughly 70% of deals fail to meet expectations for return on investment.
Here are three “straws in the wind” that add to our belief that corporate use of cash, and the company's overall cost of capital, will draw increasing attention from activist investors:
• Ralph Nader's challenge to Cisco Systems: Nader is campaigning for Cisco to redirect its $43 billion cash stash — nearly 50% of its beaten-down market cap — to pay a $1 per share special dividend and raise the recently instituted dividend to 50 cents annually from 24 cents. One could well ask where the Cisco directors have been when capital allocation came before the board: This is a company that repurchased $70 billion of its shares at $20-plus, and sank another $34 billion into acquisitions. As we write, the share price has fallen to around $15. Since the start of 2001 Cisco has earned a negative return of 55% (!) while the Nasdaq composite gained 13%. Over $104 billion of shareholder cash has totally vaporized over the past 10 years, with not a single cent of the company's free cash paid out to shareholders until a dividend was instituted in October 2010.
• The agenda at a recent Wall Street Journal convocation of “a select group of the world's leading chief financial officers”: Four of the top five priorities called for more strategic use of cash. Look at the language bandied about: “Become a Strategic CFO … Drive Value Through Capital Appreciation … View Cash as a Strategic Tool … Provide Short-Term and Long-Term Balance … Ensure that the Board Understands the Sources of the Company's Long-Term Value Creation and How Those Sources Are Being Nurtured.” Enough said.
• The convergence of global governance activism: Let's note that we in the U.S. are way behind the curve here. For as long as we can remember, U.K. and European governance rules have called for shareholders to authorize the size, and basic terms, of proposed share buybacks.
How wasteful it is, really, to be focused on such “good governance” proposals as separating the chairman and CEO roles or on all those calls for more reports to shareholders on various social and environmental issues when the vast majority of companies are not doing an adequate job of explaining, and asking for ratification of, their stewardship of our cash. This is something that goes straight to the heart of directors' fiduciary duties!
Investors, start your filings. â–
This column is adapted from an essay by the author in his quarterly newsletter, The Shareholder Service Optimizer. He can be contacted at cthagberg@aol.com.