Analysis: Cash-rich companies to spur M&A, boost dividends

By Mark Potter and Simon Falush

LONDON (BestGrowthStock) – Companies sitting on a global cash pile of about $4.3 trillion are set to fuel a pick-up in takeover deals and handouts to shareholders, providing a prop for equity markets in an uneven economic recovery.

Asian businesses, bolstered by the strength of their domestic economies, are likely to be most active in mergers and acquisitions (M&A) and capital spending, analysts believe.

Firms in Europe and the United States will also look for M&A deals as a quick route to boosting earnings, but are likely to hand more cash back to shareholders and focus less on capital spending against a more sluggish economic backdrop.

“We are now seeing companies raise dividends and spend on M&A, but we do see hesitancy on the capex side and we see that continuing,” said Ad van Tiggelen, senior strategist at ING Investment Management in The Hague.

He predicted 2011 would be the best year for M&A deals since 2007, with dividend increases the highest for three or four years, helping to underpin equity markets.

According to Thomson Reuters data, companies outside the financial sector (where cash is often held as a regulatory requirement) are sitting on cash and short-term investments worth $1.88 trillion in Asia, $1.3 trillion in the United States and $1.17 trillion in Europe.

These figures all represent a higher proportion of companies’ total assets than at any time for 20 years as firms built up a buffer against a deep economic downturn and a crippled banking system.

China Mobile (0941.HK: ) has amassed the biggest net cash hoard of $42.7 billion, ahead of Microsoft (MSFT.O: ) with $33.5 billion, Google (GOOG.O: ) with $31.3 billion, Apple (AAPL.O: ) with $25.6 billion and Cisco Systems (CSCO.O: ) with $23.6 billion.

BETTER RETURNS

Jim Wood-Smith, head of research at investment manager Williams de Broe in London, believes there are good reasons for firms to keep cash levels high amid fears the euro zone debt crisis will spread, question marks over the U.S. policy of quantitative easing and risks of overheating in Asian economies.

But he thinks companies will start putting some cash to use as long as the world avoids major shocks, if only because it is earning such poor returns amid low interest rates.

“You’re earning next-to-nothing (on cash), so you’ve got to be looking at ways of making it work,” said the finance director of a European multinational company that has more than $300 million of cash on its books, speaking on condition of anonymity.

There are already signs this is starting to happen.

In the first nine months of this year, cash held by listed U.S. companies rose 9.4 percent, down from a 23 percent increase last year, and less than the average rise for the past 10 years.

At the same time, M&A deals involving U.S. companies have risen 16 percent in value, and share buybacks have more than doubled to $250 billion, according to Thomson Reuters data.

A survey by Bank of America-Merrill Lynch this month showed fund managers across the world want these trends to continue.

Some 43 percent said they were in favor of firms’ returning cash to shareholders, with 39 percent wanting a rise in capital spending, and just 12 percent seeking stronger balance sheets.

Several recent M&A deals have also been well received by investors, with the stock of the likely acquiror rising as well as that of the target, potentially encouraging companies to act.

Shares in miner BHP Billiton (BHP.AX: ) (BLT.L: ), for example, gained more than 20 percent during its ultimately unsuccessful pursuit of Canada’s Potash Corp (POT.N: ), while LVMH stock climbed last month when the luxury goods company said it had swooped in to buy a stake in rival Hermes (HRMS.PA: ).

“We think that 2011 will be the year when redeployment of cash piles and/or an increase in gearing (debt-to-equity ratios) gain momentum/critical mass,” UBS European equity strategists wrote in a research report earlier this month.

SECTORS TO WATCH

Analysts believe Asian companies, emboldened by strong domestic economies and proportionately the biggest cash reserves, will continue to be the driving force of M&A activity.

According to credit-rating agency Moody’s, the amount of cash on average held by Asian non-financial companies in emerging markets outside of Japan and Australia is almost double the average level of that held by U.S. companies.

“Their mindset is totally different. They’re living in an inflationary world … and then you’re very inclined to spend cash,” said Philippe Gijsels, senior strategist at Fortis Bank, in Brussels, who tipped Asian companies to buy up commodities and energy assets in a bid to secure scarce resources.

Other M&A hotspots could include the technology and telecoms sector, which boast some of the largest cash piles.

Gijsels expects cash-rich pharmaceuticals companies could be active as well, as they look to stock up their drug development pipelines, while low-growth industrial companies could look for deals to boost revenue and generate cost savings.

A pick-up in M&A deals, coupled with higher dividends and more share buybacks, should provide a supportive backdrop for equities, said ING’s van Tiggelen, arguing that this would keep the cash mostly within the financial system, rather than spreading it across the broader economy.

“Not much capex activity is good for equities. It’s perverse … but the way things are,” he said.

(Additional reporting by Michael Tarsala in New York; Editing by Bernard Orr)

Analysis: Cash-rich companies to spur M&A, boost dividends