Peer Insight: The Tech20 Treasurers’ Peer Group 2013 Annual Meeting
Tech20 treasurers discussed how best to fund on-going shareholder distributions that “tax” domestic cash flows and keep their investors happy.
With the prospects of a US tax reform to fix the offshore cash conundrum remote, Tech 20 members marked their 13th Annual Meeting (sponsored by BNP Paribas) in November 2013 by focusing on various ways to maintain their current path of issuing debt to fund dividends and share repurchases. Fortunately, debt capital markets look to be receptive to tech issuers and this is likely to be the case for some time. With US interest rates expected to continue to stay low—thanks to tempered expectations about overall post-crisis GDP growth and employment rates, plus forward guidance—borrowing is likely to beat the cost of repatriation for some time, too. Rating agency sentiment, meanwhile, appears to be on Tech20 treasurers’ side, allowing them to keep issuing debt to return cash to shareholders without too much concern over the rating impact. But what makes borrowing easier, also makes investing the cash balances remaining more challenging. Here are some further highlights from the meeting:
1) So long as tech issuers avoid taper panic periods, the market reception will be very good. Members shared insights on issues pre-taper panic and another noted how his turn to the euro market in July 2013, to move away from it, met with strong demand. BNP Paribas’ Tim McCann, head of US syndicate, and Mark Howard, head of US credit strategy, suggested further that tech has maintained its distinctiveness from telecom issuers that have saturated the bond markets (see Verizon, most recently), and therefore tech issuers are likely to continue to enjoy better relative spreads and demand.
2) Ratings seem to be accommodating the new normal of tech bond issuance and dividends. Moody’s Rick Lane participated in a session that suggested there is acknowledgment on the part of rating agencies of what the offshore cash situation means in the current state of the sector. Moody’s still seems comfortable with tech’s relative cash levels, even given the growing off shore portions along with increasing use of dividends to return cash.
3) Reconsidering the cash investment norm. The discussion of cash investment management practices revealed that while the norm is still to be conservative with excess cash, there is a growing minority that is crossing the Single-A rating threshold and considering additional asset classes in the name of diversification for portfolios of size. The rest will be building their own money market fund equivalents in separately managed accounts and looking to certain eager banks to bid for their deposits.
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Member Debt Issuance Experiences
Members shared key takeaways from large bond issues from earlier in the year, and for what follows when you don’t time the market right and need to search for alternatives. Members also discussed unique aspects of a convert deal, for companies who still do not wish to become regular bond issuers.
Key Takeaways
1) Structure debt issuance to balance cash portfolio. Prudent ALM for companies with duration in their cash portfolios may wish to offset that with some longer duration liabilities and thus not be so quick to swap back a longer-term bond issuance to floating.
2) Use a tight group to make the process as efficient as possible, keep the deal a secret and issue on time. For a first time issuer, especially, it is important to have a well defined project plan, tight workstreams and frequent communication with a small group of lead bookrunners.
3) Acknowledge rating agency leverage ratios and state intention to maintain significant net cash. A debt issuing member said the one concession made to rating agencies was to agree to maintain significant net cash, even if the need arose to repatriate offshore cash, and to promise not to issue again in 2013. Agencies might seek to apply a leverage test but that does not mean your firm needs to agree to it.
4) If you get caught out, there are alternatives. What if you need to issue when the timing isn’t right in the US? One member described a situation where his company needed to issue to meet domestic spending needs, including share buybacks. As it prepared to issue, US rates were still low, but as June rolled around this was no longer true. Since the company had to move, it decided to look more to the euro markets where coupons remained low.
outlook
Tech companies can continue to issue debt and see strong demand relative to more mature corporate sectors so long as they maintain significant net cash levels. The window of opportunity to fund at historically low rates is closing, however.
A Conversation with Private Equity
A notable private equity firm responded to member questions about how they look at the tech sector and evaluate investment opportunities. Reiterating the theme from the start of the day, this firm noted that part of the evaluation process must reconcile the fact that growth opportunities are not what they once were; but, even so, tech has the ability to outperform and will contribute to productivity gains throughout the economy.
KEY TAKEAWAYS
- Looking for companies where P/E/G ratio has been undone by overly pessimistic fear. This it also includes companies like Dell, which represents a company in a sector that is undergoing transformation and that has multiple ways to win with a proven proficiency in a business model that can work in more than one type of market.
- Activism creates alpha, so it will remain an asset class. In general activism is pro-cyclical and its effectiveness will wane once the cycle turns. Tech, however, remains vulnerable because balance sheets in the sector tend to be least efficient with too much net cash. This will force boards at tech companies to look at recapitalization and M&A activity.
- Friendly transactions where you work in partnership with the target add the most value. Also, unlike most activists, this PE firm only engages in friendly transactions where it can work with existing management to improve the business through its transformation period. This is something member firms should keep in mind if they decide to pursue their own M&A opportunities.
OUTLOOK
Perhaps the key to investing successfully in the current environment is to understand how much more volatility comes into play. A small news event can trigger a big move in price—perhaps much more than is justified. While generally speaking valuations are reasonably fair for most firms given today’s lower-growth environment, there is greater sensitivity to risk as everyone is walking on eggshells. This creates windows of opportunity to buy if you are ready for them. Look for opportunities for growth at a discount, especially situations where free cash flow is strong and stable.
Changing Rating Agency Perspective
Moody’s and BNP Paribas shed light on how the rating agency perspective on tech debt issuance is evolving. One clear way it is evolving is in how rating agencies choose to acknowledge the growing portion of offshore cash in tech companies’ net cash positions. Rating agencies have had to come to terms with what the off shore cash situation truly means in the current state of the sector.
Key Takeaways
1) Cash levels still sufficient, even with growing portions offshore. While Moody’s is not moving toward as much accommodation as S&P apparently is on accepting a net debt view on leverage, it still seems comfortable with tech’s relative cash levels, even given the growing off shore portions along with increasing use of dividends to return cash. Less accommodation, however, was indicated on the question of allowing cash-rich tech companies to forego CP back-up lines without a potential long-term rating impact.
2) No problem dealing with blunt CEOs. Members expressed concerns about putting CEOs in the room with rating agency analysts, where they might say something unkind about how rating agencies want them to manage their business. However, the Moody’s analyst said that these conversations are welcome regardless and would not adversely impact a rating decision. The more communication, the better was the analyst’s advice.
3) 12-18 month window to prefund without adverse rating impact. Asked what a reasonable time period was where firms would be allowed to pre-fund commitments to take advantage of the current rate environment, Moody’s suggested 12-18 months was reasonable, but there is no bright line. It helps to have good communication with the rating analyst as to the company’s situation and the intended use of proceeds. Several members pointed out that this is less than the three years the rating agencies provided firms ahead of HIA.
outlook
As S&P has inched closer to European net debt considerations in credit ratings, it will be interesting to see how much Moody’s sticks to the view of not formally factoring in off shore cash into leverage calculations for cash-rich firms. Given that investors increasingly are not relying on ratings, it may be becoming immaterial, as a panel of investors to follow confirmed. Meanwhile, members do seem to be getting accommodations based on the cash generating ability that lies behind their cash positions, which somewhat mitigates the fact that Moody’s is not letting itself get pinned down on a “cash factor.” In short, ratings do not appear to be the show-stopper for borrowing to avoid the tax consequences of repatriating offshore cash.
Foreign Exchange—the Shale Revolution and the USD
As the US shale revolution continues, BNP Paribas illustrated the potential consequences for the US dollar.
KEY TAKEAWAYS
- US Shale Oil Revolution ticks the box for longer-term economic growth. With economic growth stimulus needed, increases in US shale oil production fit the bill. They will lead to increases in natural resources available to US business, investment in physical and human capital, improvements in technology and new institutional frameworks to encourage subsequent growth. Indeed, the US will see a six-fold increase in its oil exports and three-fold increase in natural gas as it takes a growing share of rising oil and gas production and becomes energy independent.
- US moves from importer to exporter of energy. Shale production will switch the direction of international oil trade that has seen China surpass the US as the largest oil importer. As a result, 90 percent of Middle Eastern oil exports will be drawn to Asia by 2035.
- The growth and trade factors will strengthen USD over next decade. According to a BNP Paribas FX strategist, all this could benefit the USD’s fundamental equilibrium exchange rate (FEER) by as much as 16 percent in the next decade.
OUTLOOK
While not everyone bought into the shale revolution scenario, it would have a profound impact on decisions to hedge the dollar or forgo hedging as was contemplated earlier. It would also impact decisions to continue to bill in dollars, which has been the norm for tech since Intel decided to bill for semiconductors globally in dollars to prevent grey market arbitrage. Regardless of the degree to which members thought the impact realistic, the big question it left them was: if not this, what else will spur better US economic growth over the next ten years?
Changing Practices in Cash Investment Management
Members reviewed cash investment management processes and benchmarking for large cash portfolios, to see where their own practices were in relation to the norm. Thereafter, Rudy de Candé, director, and Jim Santoro, director, Global Liquidity Advisor at BNP Paribas shared their thoughts on how cash investment management is changing.
Key Takeaways
1) A growing minority crossing the Single-A threshold. Six of the pre-meeting survey respondents indicated they had policies allowing investment of cash in securities rated below Single A.
2) Few earning returns above 1.5 percent. Just one respondent in the pre-meeting survey said their cash portfolio earned a return greater than 1.5 percent in the past year (ended June 30, 2013). Little wonder as, overall, cash portfolio asset allocations, remained heavily weighted toward money market funds, US Treasuries and Agency Debt, Corporate Bonds above the Single-A threshold and corporate CP/CDs.
3) Money market reform driving members into build-your-own equivalents and deposits. The clear consensus of the discussion was that if reforms ended up with the need to mark variable NAV funds to market, members would simply mark funds of their own creation to market. This is a continuation of the already pronounced trend by Tech20 members to build their own short-term funds in separately managed accounts. More may also want to investigate bank deposits with certain banks bidding for corporate deposits in certain jurisdictions where they need them in response to bank regulation. Given that operating cash deposits are better than traditional time deposits, look for banks to continue seek to create structured products that can be labeled operating deposits for regulatory purposes but pay more like time deposits.
4) Investment committees under review. Several members indicated looking afresh at investment committees formed to help guide investment decisions.
One member indicated that he felt his had become something of a bureaucratic obstacle to timely investment actions rather than a value added review. Others also cited turnover, attendance and conflict of interest concerns. Having an investment committee might also contribute to 1940’s Act requirement concerns, which a few members cited as a recurring consideration. For the most part, however, external investment managers and the advice and research they provide seem to be offering members greater value in guiding investment decisions.
outlook
Against the backdrop of many of the issues under discussion, including the constant threat of activists who might call out members if they ever get too aggressive with their cash investments (and exceed their earnings impact thresholds), it is likely that we will see continued, but gradual changes in cash investment approaches to stress diversification with a more sophisticated understanding of risk. This is what prompted one member company to change its credit thresholds and is what pushes another into new asset classes. It makes no sense to let a rating thresholds create concentration risk or limit non-rating views on risk from keeping the cash portfolio from the efficient frontier of risk/return. Nor does it make sense to let accounting-driven currency concerns prevent cash-rich US corporates from investing offshore cash in non-dollar denominated assets. Meanwhile, new wrinkles with bank deposits may replace some of the traditional money funds, but money market reform is also pushing corporate cash out into “risk assets.” So long as members understand the risks in these, this is not necessarily a bad thing, as it will make their investment portfolios and their asset liability management stronger.
CONCLUSION & NEXT STEPS
In line with the lowered expectations of the new normal, which was one of the themes highlighted by BNP Paribas’ Economist for North America, Bricklin Dwyer, at the start of the meeting, Tech20 members could leave the meeting feeling relatively good about themselves. While tax reform to allow repatriation of off shore cash is not in the offing, debt capital markets still look receptive to tech issuers seeking to substitute debt for available cash. Investor and rating agency sentiment appear to be on Tech20 treasurers’ side, as the tech sector is expected to continue to punch above its weight as a contributor to US growth.
The next meeting will be April 24, 2014, hosted by Oracle.