Watch one of those nature shows on the big cats, cheetahs, lions, and tigers, and you quickly learn something: These animals are at greatest risk of harm when they are in the process of an attack. A stray kick, a flying horn -- these are the things big cats must deal with if they wish to eat. And so they do. It's necessary, prudent risk.
Companies work the same way. The ones that grow and prosper take risks. These risks can leave them vulnerable, but as the AIG (NYSE: AIG) ads say, "Sometimes the greatest risk is not taking one." That's why it baffles me that there aren't more companies with big purses out there taking risks -- while they could pick up assets, in-process research and development, and promising technology and products on the cheap.
I've got a term for it: cowardice. OK, OK, maybe that's a little macho. After all, we want our executives to make prudent decisions with our investment dollars, right? There's no need for companies just to go out and take flyers and hope they turn out well. But companies that worry about the results for the next quarter too much are unlikely to spend the money to make themselves dominant over the course of years.
I'll give you an example. Cisco (Nasdaq: CSCO) has almost $21 billion in liquid assets just sitting in its coffers. Yes, business is awful for Cisco at present. But is there any risk of it going out of business anytime soon? There is not. More importantly, it could be just as safe, as it is the market leader, with a tenth of its cash hoard. I'm not advocating Cisco go out and blow billions. But this is a company that proved itself all too willing to overpay for acquisitions during the boom times. Why not take advantage when the bloom is off the rose?
The company that for a time scared the bejeezus out of Cisco, Juniper Networks (Nasdaq: JNPR) currently has a market cap of $3.3 billion. Two years ago, it was $70 billion. Cisco could buy it without blinking and still have enough to buy the entire planet lunch for several days. Just ask Ericsson (Nasdaq: ERICY) if it could go back and buy Nokia (NYSE: NOK) as it had the opportunity to do when it was struggling.
Cisco could also deploy hundreds of millions of dollars into R&D, at a time when most of its competitors are paring back. Basic economics -- things are cheaper when they are not in demand.
Several companies do this. Applied Materials (Nasdaq: AMAT), for example, is famous for taking advantage of its leadership position in a cyclical business by waiting until the cycles are down to press forward its spending in anticipation of the next leg up, where its competitors have neither the resources nor the fortitude to do so. This, then, translates to the remainder of the semiconductor fab producers endlessly lagging behind Applied Materials. It leads its industry for the very reason that it is most active when its competitors are hunkering down. That makes for lumpy earnings, and that is a good thing if the company's earnings power over the long term is enhanced.
For the longest time, companies had a sort of moral contract with their investors, which said that if they did not have a good place to invest money, they would return it in the form of a dividend. Companies such as Cisco and Microsoft (Nasdaq: MSFT), and, even to some degree, Berkshire Hathaway (NYSE: BRK.A), with their multi-billion dollar war chests, have blown this contract to smithereens.
Shareholders take a fair amount of culpability here -- as long as share prices spiraled, many of them didn't even want companies to return money to them. As evidenced by Cisco's shareholders rejecting a dividend last month, many still don't. Berkshire shareowners have two excuses. First, the company is foremost an insurance company and thus needs a broad capital base. Second, Warren Buffett has a decades-long record of fantastic capital deployment.
But what of the others? Why don't they do something? For the same reason that individuals don't "do something" while the stock market is in the doldrums. There is no real hope for short-term gain, and as such the investment seems like a waste. It isn't, as proven by the commanding position that Applied Materials' strategy creates for the company. "Buy when others are afraid" works on the corporate level, as well. Heck, that's what the 12 Fed rate cuts have been about -- to get companies to spend more.
There are, of course, plenty of reasons why executives are not spending -- and some of them good. One need only look at the experience of Cable & Wireless (NYSE: CWP), which parlayed its pristine balance sheet into what seemed to be some savvy acquisitions as the rest of the telecom industry lay in a world of hurt. Sadly, things have remained so grim -- and promise to get worse -- for telecommunications carriers that C&W's move proved to be costly and too early.
Another reason is that so many companies are currently deep in debt. For them, it's obvious why they don't want to spend: Any additional drop in equity could put their debt covenants into play. Taking risks, at that level, isn't prudent.
But for the companies that have some balance sheet power, it doesn't seem like there would be a better time to deploy some assets than now. It seems companies are so concerned about their quarterly numbers that they're terrified to spend while sales are down. That's not managing a business; that's managing a stock. But such short-term thinking potentially could stunt growth in the future. And for those that wait until times are good until they start spending? Guess what? They'll pay too much.
If you're holding a company that has billions (or for a smaller company, millions) of dollars in liquid assets on its balance sheet, you might want to ask yourself "Why?" If the answer is simply that these companies are hoarding power for a rainy day, then look outside. The clouds are black, and this could be a golden opportunity for them to ensure their positions for when the sun comes out again. It makes no sense to hold that amount of cash in the company if it doesn't have a firm idea what to do with it.
Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards
[Editor's note: This article was revised on Dec. 10 to correct a factual error.]
Bill Mann's looking for his car keys. He owns shares of Nokia, Berkshire Hathaway, Cable & Wireless, and Cisco. He is managing editor of The Motley Fool Select, where you can find his best Foolish stock ideas you won't find anywhere else. The Motley Fool has a disclosure policy.
The Rule Maker Portfolio has had a cumulative investment of $43,500. As of Nov. 26, 2002, its current value of all cash and equities is $30,331.53. This equals an internal rate of return of -11.9% since the launch of the portfolio in February 1998.
