Successful Value Creation Requires Avoiding the 'Cash Trap'
BCG Annual Value Creators Report Shows Many Companies Find It Difficult to Deploy Growing Cash Reserves to Generate Superior Shareholder Returns
BOSTON, MA--(Marketwire - October 2, 2007) - A combination of record profits, strong balance
sheets, and modest growth opportunities is creating a "cash trap" that is a
drag on near-term total shareholder return (TSR), according to a new report
from The Boston Consulting Group (BCG).
"Avoiding the Cash Trap: The Challenge of Value Creation When Profits Are
High" is the ninth in BCG's annual Value Creators series. Starting from a
database of close to 5,000 global companies, the report presents detailed
analyses of TSR at 610 companies across 14 major industries for the
five-year period from 2002 through 2006.
The report argues that in many industries, there is too much cash chasing
too few organic growth opportunities. Competition for those opportunities
is making it harder to create long-term value. In addition, many companies
are finding it increasingly difficult to deploy their growing cash reserves
in ways that will generate superior shareholder returns. In some cases, too
much cash on the balance sheet is even exposing companies to predatory
attack by activist shareholders and private equity firms.
"There was a time when accumulating cash on the balance sheet wouldn't have
been much of a problem," said Eric Olsen, BCG's global leader for
integrated financial strategy and coauthor of the report. "Not anymore. In
today's capital markets, having large reserves of cash, excess free cash
flow, or untapped debt capacity not only depresses a company's near-term
TSR but, in some cases, also paints a big target on a company's back and
raises the risk of breakup or takeover."
According to the authors, the cash trap is likely to persist despite the
recent tightening of global credit markets. Indeed, tighter credit may even
exacerbate the problem. As the cost of debt rises, companies may become
more risk averse and institute higher hurdles for returns from their growth
investments, further constraining their growth opportunities.
The chief consequence of the cash trap is that a public company's room to
maneuver is narrowing. Increasingly, companies must create more value in
the short term in order to earn the right to create value in the long term.
"There are times when a company has to focus on the short term in order to
maintain control of its destiny," explained coauthor Daniel Stelter, global
leader of BCG's Corporate Development practice. "That is the situation
today. Yet at the same time, executives must not become so focused on the
near term that they neglect their company's long-term prospects. The
solution is to strike a delicate balance -- to invest sufficiently in
growth for the long term but in a way that also wins favor from investors
today."
"Avoiding the Cash Trap" examines how senior executives can address this
challenge. It also presents new research that compares the impact of
different uses of cash on shareholder value. For example, the report shows
that increases in dividend payout have a more positive impact on TSR than
share repurchases do.
"Despite all the recent attention given to share repurchases," said
coauthor Frank Plaschke, project leader of BCG's Value Creators research
team, "in every industry we studied, share changes actually reduce TSR on
average. In other words, the amount of shares companies have been buying
back has been more than equaled by the new shares they are issuing for
executive stock options or using as equity for acquisitions. What's more,
the impact of dividend payouts on a company's valuation multiple is far
more positive than that of share buybacks. In some cases, buybacks cause a
company's multiple to decline."
Using examples drawn from BCG's client work, the report describes how
companies can manage the critical trade-offs around cash, avoid the cash
trap, and optimize both near-term and long-term value creation.
To receive a copy of "Avoiding the Cash Trap," or to schedule an interview
with one of the authors, please contact Eric Gregoire at + 1 617-854-4570
or gregoire.eric@bcg.com.
About The Boston Consulting Group
The Boston Consulting Group (BCG) is a global management consulting firm
and the world's leading advisor on business strategy. We partner with
clients in all sectors and regions to identify their highest-value
opportunities, address their most critical challenges, and transform their
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competitive advantage, build more capable organizations, and secure lasting
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countries. For more information, please visit www.bcg.com.
Contact Information: Contact:
Eric Gregoire
+ 1 617-854-4570