2014 Cash Update: Cheap Debt Fuels Record Cash Growth

Primary Credit Analyst: Andrew Chang, San Francisco (1) 415-371-5043; andrew.chang@standardandpoors.com Secondary Contact: David C Tesher, New York (1) 212-438-2618; david.tesher@standardandpoors.com Research Contributor: Ka-Kin Leung, San Francisco (1) 415-371-5015; ka-kin.leung@standardandpoors.com

Table Of Contents
U.S. Corporate Cash Balances Reach Another Record High Appendix Notes

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U.S. nonfinancial corporate cash holdings marked a record year in 2013. Standard & Poor's Ratings Services' rated universe of U.S. nonfinancial corporates (about 1,700 issuers)* held a total of $1.53 trillion in cash and short-term investments at year-end, an increase of 11% from 2012. (See the appendix for detailed analysis of cash distribution by rating, industry, and domestic versus overseas.) Less discussed, however, are the drivers of this cash growth. Specifically, we found that availability of debt played an important role among our rated issuers. For example, for every $1 of cash growth, debt increased by $3.67 over the past three years. For the 25 largest cash holders (1.5% of all issuers) that control 43% of the overall cash balances, cash growth in 2013 was largely matched by similar growth in debt outstanding. The 15 largest cash holders that disclose their overseas cash holdings (now at 76% of total cash) grew cash entirely from overseas in 2013, then synthetically repatriated it through matching debt issuances. (Watch the related CreditMatters TV segment titled, "Cheap Debt Fuels Record Cash Growth For U.S. Corporations," dated April 14, 2014.) In our view, availability of cheap debt has been most responsible for the record cash balances. Cash flow from operations appears sufficient to support ongoing share repurchases, dividends, and capital expenditures. However, companies generate much of their cash flow offshore, rendering it mostly inaccessible because of the high cost of repatriation, and leaving companies with domestic cash deficits they must replace with debt issuance. In other words, liquidity appears plentiful, but accessible liquidity is not. Nevertheless, activist shareholders are pushing for greater access to this far-flung cash. We expect rising overseas cash balances, coupled with continuing debt issuance to meet domestic cash needs, to lead to higher overall cash growth in 2014. Overview Standard & Poor's rated universe of U.S. nonfinancial corporate entities is currently hoarding a record $1.53 trillion of cash and short-term investments, an 11% increase from 2012. We attribute all of the cash growth in recent years to robust credit market conditions, with our analysis indicating that for every $1 of cash growth, debt rose by $3.67 over the past three years as companies issued debt in lieu of repatriating cash held overseas. Shareholders are pushing for the return of this cash. Given the high level of cash trapped overseas, we expect continued debt issuances to support domestic cash needs, including share repurchases, leading to higher total cash balances in 2014.

U.S. Corporate Cash Balances Reach Another Record High

After rated U.S. nonfinancial corporate issuers marked their record year for cash in 2013, we analyzed only the issuers we rated over the past five years (about 1,100 issuers). We found that cash and short-term investments increased a total of 71% since the end of 2008, with much of the growth coming from the already cash-rich technology industry

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and large investment-grade issuers (see appendix). The ratio of cash and short-term investments to total assets, which jumped from 7% prior to the recession to about 9% by 2010, has yet to return to pre-recessionary levels, despite the gradually improving economic outlook. In fact, our analysis indicates that this ratio is now even higher, at almost 10%, as of year-end 2013 (see chart 1).
Chart 1

Debt grows almost four times as fast as cash

The balance sheets of issuers that Standard & Poor's has rated during the past five years reflect changes for both the economy and credit market conditions. During the height of recession from 2008-2010, cash balances grew by about $300 billion, while debt levels increased nearly $100 billion. For every $1 of cash growth, debt increased by just $0.32 during this period. This aggressive cash growth built up through delayed investments, aggressive cost-cuts, and lower spending on share buybacks, all while the debt market remained closed to all but the strongest of credits (see chart 2). During 2011 to 2013, cash continued to grow, by nearly $200 billion, despite a modestly improving economy. In contrast, debt levels jumped by about $750 billion. In other words, for every $1 of cash growth, debt increased by an astonishing $3.67 over the past three years, an 11-fold increase from the $0.32 mentioned above. We attribute recent cash growth partly to the modestly improving global economy, continued buildup of overseas cash, and most importantly, the robust credit market conditions offering access to cheap debt.

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New debt accounts for most of cash growth in 2013

Another way to view the source of the cash growth is by analyzing the trends among the large cash holders. For the 25 largest U.S. cash holders, who account for only 1.5% of total issuers but control 43% of the overall cash, total cash and short-term investments grew by $115 billion to $656 billion during 2013 (see table 1). At the same time, total debt outstanding increased a similar $105 billion. So why would a company issue debt when the cash appears to be plentiful? Cash flow from operations has been increasing since the end of the recession for U.S. corporate borrowers and generally appears sufficient to support ongoing share repurchases, dividends, and capital expenditures. However, as companies become more global, they have been generating an increasingly higher portion of their cash flow from overseas, which is subject to taxes as high as 35% upon repatriation. While most of the cash uses are domestic in nature (share repurchases and dividends, especially), cash flow is increasingly generated from overseas, leaving companies with domestic cash deficits even as overseas cash piles up.

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Table 1

Top 25 Issuers With The Largest Cash Holdings As Of 2013

Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Total YoY change (%) YoY--Year over year. Company Microsoft Corp. Google Inc. Verizon Cisco Systems Inc. Apple Inc. Oracle Corp. Pfizer Inc. Johnson & Johnson General Motors Co. Ford Motor Co. The Coca-Cola Co. Intel Corp. Amgen Inc. Merck & Co. Inc. Chevron Corp. Hewlett-Packard Co. Boeing Co. General Electric Co. Chrysler Group LLC Medtronic Inc. Amazon.com Inc. IBM Corp. EMC Corp. AbbVie Inc. DISH Network Corp. Rating as of December 2013 AAA AA BBB+ AAAA+ A+ AA AAA BB+ BBBAAA+ A AA AA BBB+ A AA+ B+ A+ AAAAA A BBCash and short-term inv. (mil. $) 83,944 58,717 54,129 47,065 40,711 36,974 32,498 29,206 27,919 25,116 20,268 20,087 19,401 17,486 16,516 16,165 15,225 14,005 13,344 13,667 12,447 11,066 10,664 9,895 9,739 656,254 Total debt (mil. $) 22,976 5,245 93,591 17,147 16,961 23,126 36,489 18,180 7,137 15,683 37,079 13,446 32,128 25,060 20,431 24,592 9,635 13,356 12,301 12,219 6,940 39,718 7,159 14,723 13,651 538,973 Cash (YoY mil. $) 15,632 10,629 50,566 689 891 3,279 (210) 8,117 1,578 691 3,717 1,925 (4,660) 1,345 (5,397) 3,576 1,667 (1,578) 1,702 11,203 999 (63) 4,497 1,919 2,502 115,216 21 Debt (YoY mil. $) 8,788 (292) 41,604 856 16,961 3,369 (971) 2,015 1,920 1,427 4,469 (2) 5,599 4,491 8,239 (3,635) (774) (4,113) (302) 801 1,891 6,449 5,449 (949) 1,763 105,053 24

Debt issuance is a form of synthetic cash repatriation

Although most companies do not report their cash holdings by region, we found that the top 15 cash holders that disclosed this information for the past three years raised cash balances by 14% (or $44 billion) during 2013. Of this growth, the companies generated $45 billion overseas, indicating that domestic cash balances actually fell $1 billion during the year. Most importantly, debt issuance by these 15 companies totaled $45 billion, exactly matching their overseas cash growth. In other words, these large cash rich issuers completely exhausted their domestic cash flow and had to issue an additional $45 billion in net new debt to meet domestic cash needs, mostly in the form of increasing share repurchases. We believe most of these issuers did not intend to have such a large cash pile sitting on the sidelines. If given the

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choice, most would prefer to repatriate the cash and limit debt issuance. However, investors are demanding greater returns through share buybacks and dividends. Given the limited domestic cash flow generation and reticence to repatriate cash at the current tax rate, companies are issuing debt as a form of synthetic cash repatriation. The ratio of overseas to domestic cash supports this thesis. These 15 issuers held 69% of their cash overseas in 2011, which subsequently rose to 72% in 2012 and to 76% in 2013. It is our view that without access to the accommodating credit markets, companies would likely not have provided the returns that shareholders have become accustomed to in recent years (see chart 3).
Chart 3

Case study: cash keeps rising, and so does debt

Repeated over time, synthetic cash repatriation results in ever increasing cash balances and rising debt. For example, Cisco Systems Inc.'s overseas cash balances continue to trend higher while its domestic cash balances have remained between $3 billion and $9 billion over the past eight years (see chart 4). In the meantime, the company's outstanding debt has increased from $6 billion to $21 billion to supplement its low domestic cash balances. Cisco's $8 billion bond issuance in February 2014 improved its domestic cash position for now, but we expect overseas cash growth to continue over the intermediate term outside of a tax policy reform.

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Chart 4

Cash growth will continue as long as the credit market remains accessible
The ever-growing cash balance represents different ideas to different stakeholders. For a company with global operations, it is the result of a U.S. tax policy that puts it in a competitive disadvantage versus its non-U.S. peers. For shareholders, it represents the company's ultra-conservatism and an inefficient capital structure. The rise of activist shareholders in 2013 supports this view. We believe the cash represents both a liquidity cushion over the near term and, more importantly, a potential long-term credit risk, given the accompanying debt is rising even faster. It isn't conservatism by the issuer, but simply a result of synthetic cash repatriation born out of necessity and an accommodating credit market full of yield-starved investors. Rising gross leverage through 2013 reflects the credit risk inherent in the current debt market. Companies may have hoarded cash out of fear during the recession, but current cash growth is a reflection of the Federal Reserve's cheap money policy and a U.S. tax policy that discourages its return because of the competitive disadvantage companies who repatriated this cash would then be operating under. With no near-term shift in policy or a tax holiday in sight, we expect cash growth to continue even as the Federal Reserve raises rates in 2015. On the other hand, if Congress implements a tax holiday similar to the American Jobs Creation Act of 2004, we could see a mad rush of repatriation among the cash rich, likely enriching shareholders in the process while leaving the creditors with the remaining debt. Activist shareholders should be aware: companies aren't as rich as they appear.

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Appendix
In this section, we provide a more in-depth analysis of cash balances by reviewing trends among investment-grade versus speculative-grade issuers, rating categories, and industries.

Investment-grade companies maintain a bigger slice of the pie

Our analysis of cash balances shows a marked bifurcation between investment- and speculative-grade issuers. In all, cash and short-term investments rose 11.3% on a compounded annual growth rate (CAGR) for the issuers we rated over the past five years. Specifically, investment-grade issuers grew the cash balance at 13.9% CAGR, in contrast to the 1.6% CAGR recorded by speculative-grade issuers. This growth spread (12.3%) is nearly double the rate recorded two years ago (6.4%), highlighting the investment-grade issuers' ability to maintain and enhance their liquidity, not just through operations, but also through access to the credit market (see chart 5).
Chart 5

Issuers in the 'B' rating category or below, which accounts for 49% of the total number of issuers, had only 7% of the $1.52 trillion in total cash and short-term investments as of year-end 2013. The speculative-grade issuers on average experienced greater percentage revenue declines and reduced operating cash flow through the recession as well as a slower recovery through the current expansion. These companies are usually smaller, have higher concentrations of

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domestic cash flow (which is more easily distributed to sponsors or shareholders), and have greater percentage debt and interest expense burdens. As a result, we expect speculative-grade issuers' cash growth to continue to lag that of investment-grade issuers. In contrast, companies in the 'A' category or higher, which account for 10% of the total number of issuers, have 53% of the total cash and short-term investments as of 2013 (see chart 6). For many of these large issuers, domestic cash on hand and cash flow generation have been insufficient to fund the ever-growing shareholder returns and acquisitions.
Chart 6

Rich keep getting richer, but not by choice

The top 25 largest cash holders, which make up approximately 1.5% of the total rated issuers, accounted for about 43% of total cash and short-term investments as of 2013, an increase from 40% as of 2011 (see chart 7). Furthermore, the top 50 largest cash holders now make up about 55% of the total pie. Part of the growth is the result of the inclusion of new issuers, such as Apple Inc., but much of it is related to the easy access to the credit markets among investment-grade issuers, which has allowed overseas cash to grow untouched.

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Chart 7

Two industries hold almost half the cash

Cash and short-term investments are concentrated in two sectors: technology at 31% ($480 billion) and health care at 13% ($206 billion) of the total corporate cash holdings (see chart 8). In fact, the technology sector's cash concentration has increased from the 28% reported in 2011. The technology sector's "cash problem" is more apparent when viewed within the balance sheet. Its cash and short-term investments (excluding long-term investments) now make up a quarter of the total assets, a significant jump from five years ago, when it comprised just 17% (see chart 9). Considering the overall corporate average of 10%, it is no wonder activist shareholders are circling Silicon Valley.

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Chart 8

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Chart 9

Overseas cash continues to grow

Of the top 15 largest issuers disclosing their overseas cash positions, 76% of the overall cash was held overseas, an increase from 72% in 2012 and 69% in 2011. These issuers grew overall cash by $44 billion, or 14%, during 2013 (see table 2). Overseas cash accounted for $45 billion of this cash growth, with domestic cash actually declining by $1 billion. Given the limited domestic cash balance for these issuers, we expect continued cash growth outside of the U.S., coupled with new debt issuances, to meet domestic cash needs.
Table 2

Overseas Cash Versus Domestic Cash

Company Microsoft Corp. Google Inc. Cisco Systems Inc. Apple Inc. Oracle Corp. Amgen Inc. Medtronic Inc. Rating AAA AA AAAA+ A+ A AACash and short-term investments (mil. $) 83,944 58,717 47,065 40,711 36,974 19,401 13,667 Domestic (mil. $) 8,244 25,117 3,265 8,827 5,774 1,617 906 Overseas (mil. $) 75,700 33,600 43,800 31,884 31,200 17,784 12,761 Percent overseas (%) 90.2 57.2 93.1 78.3 84.4 91.7 93.4 Total debt (mil. $) 22,976 5,245 17,147 16,961 23,126 32,128 12,219

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Table 2

Overseas Cash Versus Domestic Cash (cont.)

Chrysler Group LLC Amazon.com Inc. EMC Corp. eBay Inc. Priceline.com Inc. Costco Wholesale Corp. Corning Inc. NetApp Inc. Total YoY change (mil. $) YoY % change BBAAA A BBB A+ ABBB+ 13,344 12,447 10,664 9,025 6,753 6,439 5,235 5,069 369,455 12,344 6,847 5,574 2,186 1,853 3,955 1,623 1,010 89,143 1,000 5,600 5,090 6,839 4,900 2,484 3,612 4,059 280,312 7.5 45.0 47.7 75.8 72.6 38.6 69.0 80.1 75.9 12,301 6,940 7,159 4,123 1,894 4,987 3,293 995 171,494

44,300 13.60

(700) (0.80)

45,000 19.10

45,300 35.90

*Includes issuers who have reported overseas debt figures for past three years, based on company filings and S&P estimates.

Notes
*2013 year-end public filings for publicly held companies and estimation of year-end 2013 figures for privately held companies, based on most recently available financials. Excludes long-term investments.

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