Category Archives: M&A

14/11/15: More Evidence U.S. Capex Cycle is Still Lagging

In a recent post (link here), I covered the issue of shares buy-backs and the lack of capex at the S&P500 constituents level. A recent report by Credit Suisse titled "The Capital Deployment Challenge" takes a look at the same problem.

Per report: "Companies in the US market are currently in great health as corporate profitability is approaching historical highs. This high level of profitability has produced record levels of corporate cash, and thereby has created a challenge for managers: how to allocate all of this excess cash. Companies may choose to reinvest in their businesses – organically or through M&A – or they may return the cash to capital providers, through dividends, share buybacks or by paying down debt..."

"Historically, companies have deployed an average of 60% of cash flows in capital investment (28% in organic growth and 32% in M&A) and have returned  26% to shareholders (12% dividends and 14% share buybacks). In the past several years, the capital allocation balance has swung away from growth towards buybacks and dividends: capital invested has dropped to 53% (27% organic growth and 26% M&A), while cash returned to shareholders has increased to 36% (15% dividends and 21%

A handy chart to illustrate the switching:

So Credit Suisse divide the S&P500 universe into two sets of companies: reinvestors and returners. The former represents companies which predominantly direct their cash balances to organic reinvestment and/or M&A, whilst the latter are companies that prefer, on balance, to use cash surpluses for dividends and/or shares buybacks.

The report looks at three metrics across each type of company: underperformers within each group - companies that underperformed their peers average in terms of total shareholder returns, outperformers - companies that outperform their peers average, and average across all companies.

Chart below shows the extent of differences across two types of companies and three categories in terms of cash flow return on investment (CFROI):

The chart above "shows that the initial level of returns on capital is generally lower for reinvestors than for returners, with an average of 9% and 11%, respectively. The reinvestors and returners who outperformed their peers both improved their CFROI. However, the outperforming reinvestors generated a greater operating improvement (180bps vs 150bps for returners)."

Which is all pretty much in line with what I said on numerous occasions before: no matter how you twist the data, average returns to not re-investing outpace returns from investing. Meaning that: either companies are getting worse at identifying and capturing investment opportunities or investment opportunities are thin on the ground. Or both...

11/11/15: Take a Buyback Pill: U.S. Corporates Shy Away from Capex

As buy-backs of shares inch down as the drivers of U.S. stocks valuations (chart below), things are not going much smoother for the hopes of a capex cycle restart in the U.S. corporate sector.

As the following chart from Goldman Sachs research shows, 2015 has been shaping up as yet another year of decline in investment pipeline for U.S. companies. Capex and R&D investment share of aggregate cash holdings by S&P 500 companies is expected to hit 41% this year, down from 47% in 2014 and 2013 and marking the lowest reading since 2007. Worse, Goldman expects 2016 figure to be even lower at 40%.

Goldman figures relating to ‘Investment for Growth’ indicator include M&As, which in my opinion should not be considered in this context, as success rate of M&As is extremely low (historically at around 30%) and current M&A valuations are frankly bonkers. 

H/T to @prchovanec

Take a look at stripped out mix of real investment against buybacks in ratio terms, per Goldman’s reported data:

As shown above, relative weight of shares buybacks in terms of cash allocations by U.S. carpets has been on the rising trend now in comparison to Capes & R&D spending since 2009 and it has been flat since 2010 on for the ratio of buybacks to dividends. In fact, combined weight of M&As and buybacks ratio to Capex & R&D is now at 0.98, the highest since 2007.

In simple terms, there is little indication in the Goldman (and other) numbers of any restart of Capex cycle and all indication, major U.S. corporates are living in a world of surplus liquidity and shortages of investable strategies and opportunities.