SOURCE: The Boston Consulting Group

October 02, 2007 00:01 ET

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 businesses. Our customized approach combines deep insight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable competitive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with 66 offices in 38 countries. For more information, please visit www.bcg.com.

Contact Information