tMega also tackles insurance, green bonds and buying stock from a pension plan.
Members of the Treasurers’ Group of Mega-Caps who met in Foster City, Calif., this fall discussed a range of issues that have taken center stage since the US tax overhaul in late 2017. Chief among them are capital allocation and how multinational corporations (MNCs) are putting to use cash once trapped overseas that can now be deployed for share buybacks, strategic acquisitions and other purposes. In addition to sharing their projects and priorities, members talked about insurance, taxes, WACC and hurdle rates. Here are three top themes that surfaced at the day-long meeting:
1) Treasury’s Chance to Shine in Strategic Acquisitions. One member gave his peers an in-depth look at treasury’s role in a highly complex merger involving four companies. Treasury played an essential part in the transactions, keeping track of leverage and other implications under multiple scenarios. Is your department flexible enough to keep pace with complicated deals and help the business strategically?
2) Capital Allocation Decisions—Before and After. With access to trillions in cash that was kept overseas before US tax reform, MNCs are thinking long and hard about capital structure, allocation, hurdle rates and the returns they get from spent cash. One treasurer walked the group through his company’s allocation and performance assessment processes.
3) Rethinking the Share Buyback Framework. A big chunk of the excess cash MNCs now have is being returned to shareholders in the form of stock buybacks and, to a lesser extent, dividend increases. One treasurer described his company’s revamped approach to buybacks, one that emphasizes flexibility.
Treasury’s Chance to Shine in Strategic Acquisitions
One member gave the group a fascinating look at treasury’s role in a large, complicated acquisition by his company (call it A) of most of a business (call it B) that itself was bidding for a majority stake in a third company (C) in which it owned a minority stake. Then A got into a bidding war with a fourth company (D) that also wanted the stake in C. Got it? The member called the M&A activity “a massive undertaking” that’s made 2018 “a dramatic year with lots of twists and turns.” Treasury served as a key partner to the M&A team in preparing the bids and in subsequent stages of the negotiations.
KEY TAKEAWAYS
1) Leverage questions give treasury a bigger seat at the M&A table. The wide spectrum of leverage involved in the various scenarios the treasurer’s company faced (a “$50 billion swing factor,” he said) meant treasury played a much bigger role than in most deals and was heavily involved in the negotiations. Under one scenario, the company’s leverage ratio could have reached over 4x, considerably more than its target of 2. This brought “a lot of credit implications and financing possibilities,” the treasurer said.
2) Multiple scenarios mean lots of work. The huge size of the deal and the subsequent bidding for the majority stake meant the treasurer’s team had to detail the leverage implications of three different scenarios each time it met with the board, accounting for 1) the acquisition of most of B and buying the portion of C that B didn’t already own; 2) the acquisition of B and holding onto the minority stake in C but not acquiring the rest of it; and 3) the acquisition of B without buying the rest of C and selling B’s stake in C.
3) Complexity requires a creativity. Company A obtained a large acquisition bridge loan for the cash portion of its bid, enhancing the attractiveness of its offer and limiting the loan to five banks, structuring it to encourage a bond takeout financing before the deal closes. To finance the deal, A is using commercial paper, proceeds from the sale of certain assets and the proceeds of the C stake (A lost the bidding with D for the majority stake in C). The treasurer found banks supportive of the expansion of his revolving credit facility, saying banks “came out of the woodwork” to participate. This underscores that treasury’s understanding of bank relationships and wallet dynamics can bring more creativity and flexibility to banks’ acquisition finance commitments.
4) Treasury’s work is never done. The treasurer’s company faces lots of work to integrate B, requiring plenty of due diligence, post-closing planning and liability management, he said. Looking into sourcing will be a key priority since the deal is expected to generate $2 billion in cost savings. Another key goal is avoiding the need to produce stand-alone financials for B.
Insurance Questions and Concerns
The vast majority of treasurers at mega-cap companies within the NeuGroup Network oversee insurance risk management. No wonder, then, the topic generates plenty of back-and-forth at tMega meetings. At this gathering, one member said, “I’m trying to get my head around” coverage for directors and officers (D&O). He’s not alone. Among this meeting’s takeaways was a desire by members to benchmark D&O coverage amounts, policies and pricing trends to bring more transparency to a market many treasurers find opaque, with one describing it as “irrational.” To provide a benchmark, NeuGroup is preparing a survey on members’ D&O coverage.
Beyond D&O, one member complained that her company is “spending millions” and “paying way more in than we’re getting out” when it comes to property insurance and other coverage. She wants more of a self-insurance model where there is a pooling of risks that provides the company with some catastrophic coverage. This echoes comments in other tMega meetings where the subject of blended or integrated insurance has surfaced. Another member said she, too, is looking at the company’s insurance portfolio and asking, “What are we getting with the insurance we’re buying? Are we insuring the right risks, getting what we want with the investment?”
OUTLOOK
Stock market volatility, rising interest rates, inflated values and economic growth will all affect the size and pace of M&A activity in 2019—we just don’t know how exactly. But there’s no doubt that deals will remain central to many companies’ growth strategies. Treasury can elevate its standing by positioning itself to provide needed analysis and financial guidance as business units weigh their options and execute transactions. The presentation clearly demonstrated the potential importance of treasury in the M&A process and the opportunity that deals present to cement the strategic value of treasury and finance.
Capital Allocation Decisions— Before and After
Capital allocation and structure have taken on increased importance as US-based multinationals figure out how to put to use trillions of dollars freed by tax reform. In a pre-meeting survey of NeuGroup treasurer and assistant treasurer groups, two-thirds of members said they have a process to evaluate whether spending has met the expectations set when funding was requested. One member walked the group through his company’s revamped approach to the process of allocating capital and holding leaders accountable for the returns on that capital. And a Wells Fargo banker offered his take on WACC and hurdle rates.
KEY TAKEAWAYS
1) Take a holistic approach to cash deployment. The presenting member’s cash deployment model reflects the company’s increased access to cash and allows it to deploy cash to “several areas at the same time” in a more holistic fashion than the previous “waterfall” model, which was more linear and in which items were addressed in a specific order of priority. The company’s primary priorities are maintaining financial strength and a mid-A credit rating, achieving operational excellence and meeting its commitments. Discretionary cash priorities fall under two main categories: strategic growth initiatives and return of capital to shareholders.
2) Hold leaders accountable for achieving investment goals. The member described a disciplined investment governance process that holds leaders accountable for meeting anticipated returns presented in business proposals. It’s designed in part to improve the company’s operating profit after capital charge (OPACC); only investments whose projected returns are in excess of the company’s weighted average cost of capital (WACC) move on to the resource allocation phase. Once approved, any investment over $50 million is subject to a full “project investment assessment” (PIA) every year for up to five years. “It’s a much more structured view of our business portfolio than what we had in the past,” the member said. One key element: If an investment is not performing as anticipated, take appropriate action. One member asked the presenter how good the company is at “cutting the cord.” The presenter said the more focused approach has resulted in the company becoming better at “purging underperforming businesses from the portfolio.”
3) Is your WACC out of whack? A banker from Wells Fargo raised several points about whether companies adequately adjust hurdle rates to reflect changes in interest rates and other variables. One of his slides said, “Many firms have delayed lowering CAPM-based hurdles to avoid having to raise them when interest rates rise.” The bank believes that “excessive hurdle rates can lead to underinvestment and/or excess risk.” In addition, the banker noted that the cost of capital will change for tech and other companies that generate significant income offshore, due in part to the new global intangible low-taxed income (GILTI) regime that imposes a 10.5% minimum tax rate on foreign income; that rate increases to 13.125% after 2025.
Go Green (Bonds)?
During the projects and priorities session, one member shared that his company is “well down the path” of issuing a green bond. Before he had time to explain why, another jumped in to ask, “What is the argument for green bonds?” A third member spoke up to say there “is no economic reason” to sell green bonds, which governments, companies and institutions use to fund projects that are supposed to help the environment. Indeed, a Bloomberg story in July noted that gains in green bond issuance by US corporates “haven’t been fueled so much by a desire to fatten the bottom line—there’s no clear and consistent evidence of a pricing benefit—rather many companies want to burnish their brands and satisfy investor demand.” In fact, the same member who said there’s no economic motivation to issue the bonds said, “A lot of these younger kids like to participate in something green.” Another member said the bonds are “more of a marker of where you are as a company.”
Whatever the motivation, issuing a green bond requires a bit of extra work. As Bloomberg noted, “In the US green bonds usually need third-party verification and ongoing reporting, which adds extra costs. Typically, they are priced in line with similar assets and there is no evidence borrowers get a discount.” A member who is treasurer of a company that has issued green bonds said the process requires “a little more effort, but it’s not Herculean. It’s very manageable.”
OUTLOOK
Treasury’s role in determining WACC at many companies puts it center stage in the debate over how, when and where the calculation of WACC and hurdle rates needs to be changed. That will remain a critical issue as MNCs continue down the road of allocating cash freed by tax reform and assess strategic M&A, a mainstay of many companies’ growth plans. The process and calculus take on heightened importance for those companies with sizable overseas income that, until the US tax overhaul, avoided paying much, if any, tax on it.
Rethinking the Share Buyback Framework
One treasurer captivated the group with a description of how his company is approaching its stock buyback plan in the wake of tax reform and the repatriation of significant amounts of cash. In a poll of members at the meeting, half said share buybacks are an effective use of excess capital, while the other half said, “It depends.” What it may depend on, in part, is the type of buyback framework you build.
KEY TAKEAWAYS
1) Less prescriptive, more flexible. The member described the new framework as less prescriptive than the previous approach, which had a specific cadence but had given up some flexibility. Now, the company is not announcing when it will execute buybacks. The company’s goal is to “embed flexibility” in timeline parameters, measuring in years, not months or quarters.
2) No KPI magic bullet. In response to a question, the treasurer said, “I don’t think there’s a magic bullet for KPI” (key performance indicator) when evaluating the success of a share repurchase program. No matter what the size of the program, a “broader framework” is necessary to measure the program.
3) Designing the framework. The member suggested a three-point framework that included: 1) Achieving stated capital structure goals; 2) Updating the valuation thesis regularly, validating repurchase decisions through retrospective analysis and adjusting for market conditions, changing business conditions or other factors; and 3) Execution: taking advantage of multiple buyback tools to manage through open markets and blackouts, while considering volatility, ADTV, VWAP and other factors to measure program success, bank execution and other factors.
A Defined Benefit Share Repurchase
One member asked during the projects and priorities session whether any of his peers had repurchased company stock from a defined benefit plan, a move he is contemplating. Another participant said in one of her previous jobs her employer had done it. After the meeting, she explained that her former company faced the problem of selling the stock from the defined benefit plan in a way that provided fair value to the DB plan (as required) and didn’t flood the market by liquidating a sizable position. “If the company is able to buy back the shares from the DB plan, you can ensure fair value (must be an arm’s-length transaction) and mitigate any market impact,” she explained. Her recollection was the MNC used a pass-through entity to make sure the transaction was arm’s-length, whereby the DB plan sold the stock to a bank and the bank sold it to the company.
Whatever the motivation, issuing a green bond requires a bit of extra work. As Bloomberg noted, “In the US green bonds usually need third-party verification and ongoing reporting, which adds extra costs. Typically, they are priced in line with similar assets and there is no evidence borrowers get a discount.” A member who is treasurer of a company that has issued green bonds said the process requires “a little more effort, but it’s not Herculean. It’s very manageable.”
OUTLOOK
Shareholder activists, by most accounts, have not yet applied significant, widespread pressure on companies sitting on excess cash post-US tax reform. But the buyback data this year clearly indicate MNCs are not waiting to reward shareholders, and 75% of meeting participants said they have determined how shareholder returns fit into the post-tax reform steady state of their capital structure. So it’s an ideal time to revisit how your company determines the size, timing and process for buybacks. Indeed, the pre-meeting survey indicated that many members are fine-tuning 10b5-1 grids and initiating accelerated share repurchase programs in response to larger authorizations resulting from tax reform or otherwise.