Fearing Predators, Lean Companies May Bulk Up
U.S. companies have rarely looked so trim. Which is to say they have rarely looked so much like targets.
In the aftermath of the financial crisis, businesses launched a yearslong slimming effort. They were reluctant to rehire workers they fired and slow to replace equipment. As a result, an ever greater share of sales flowed to profits, and from there into corporate coffers. Companies also took advantage of low interest rates, issuing bonds to refinance debt and buy back stock.
As the economy gathers strength, companies lately have shed some of their caution. They do so with balance sheets which rarely have looked so healthy.
With their ample cash, companies' liquidity positions suggest they can easily handle any bumps. Federal Reserve figures show the quick ratio for nonfinancial firms—current assets, including cash, marketable securities and accounts receivable, divided by current liabilities—has risen to its highest level since the early 1960s.
And just as homeowners have refinanced mortgages at lower rates to cut payments, companies have engaged in a large-scale refinancing effort that has lowered their interest costs significantly. At nonfinancial firms, interest payments now eat up 14.4% of cash flow against 17% at the recession's start in 2007, according to Moody's Economics.
Moreover, many companies have locked in low rates for years to come, helping insulate them from when rates turn higher. Corporate bonds issued last year had an average maturity of 13.6 years, according to the Securities Industry and Financial Markets Association, way up from the eight-year average of a decade earlier.
Companies also have busily bought back stock. Fed figures show that net equity issuance by nonfinancial firms has been deeply negative even as debt issuance has exceeded capital spending. That is an indication that firms have been selling bonds not so much to build up their business, but to shrink their share counts.
One aim of buybacks is to boost earnings per share, but they also concentrate a company's ownership into fewer hands. Combined with low levels of balance-sheet risk, that makes for a favorable takeover environment. That is particularly so given the cash, rich stock valuations and easy credit many would-be acquirers have at their disposal.
So there has been a flurry of deals and takeover attempts lately, including last week's announcements that Dollar Tree DLTR +1.10% will buy Family Dollar and Scientific Games will acquire Bally Technologies. Meanwhile, 21st Century Fox just withdrew an $80 billion bid for Time Warner TWX +1.62% and Sprint S -3.57% abandoned an anticipated offer to buy the T-Mobile US. TMUS +0.27%
The hot deal environment should continue—which could be good news for investors in takeout candidates.
Management at those companies, though, may not be so enthusiastic: Chief executives like having their name on the door, after all. Which raises an interesting possibility: That more companies make moves aimed at making themselves a little less of a target in the months to come.
One way is to step up spending with the promise of growth. The other is to turn predator and make some acquisitions of their own. Either way, investors could no longer count on companies maintaining their slim profile.