Thursday, September 30, 2010

Looking at cash balances of S-Chips just ain't enough

A recent examination of the US technology sector's huge cash balances highlights an interesting parallel with locally-listed S-Chips. The connection? Cash balances aren't what they appear to be. What does this mean?

A recent comment by Vitaliy N. Katsenelson suggests that Microsoft's debt issuance makes zero economic sense, as the company has approximately US$39 billion in cash and short term securities on which it is earning lower interest that what it pays for newly issued debt. The move appears to be destroying shareholder value by increasing interest costs without any apparent benefit to the company. Or is this so?

• $1 billion of 0.875 percent notes due Sept. 25, 2013
• $1.75 billion of 1.625 percent notes due Sept. 25, 2015
• $1 billion of 3.000 percent notes due Oct. 1, 2020
• $1 billion of 4.500 percent notes due Oct. 1, 2040

"Microsoft intends to use the net proceeds from the offering for general corporate purposes, which may include funding for working capital, capital expenditures, repurchases of stock and acquisitions." -

Now why would a company with almost US$39 billion at its disposal need to raise US$4.75 billion to fund things like stock repurchases? The answer may lie with the location of the company's cash balances - a significant proportion of Microsoft's cash may be offshore (ie. not in the US), and repatriation of that cash back to the US could induce substantial taxes. So by raising additional capital from the bond market (which sports extremely low interest rates by the way), Microsoft is able to fund things like dividend increases and share buybacks without having to repatriate cash from overseas subsidiaries. In addition, based on balance sheet strength, the company's financial position is hardly impacted by the bond issuance, given its huge (theoretical) cash horde. 

Now, how does this relate to S-Chips? We have seen various instances of S-Chip companies which have cash holdings in excess of their debt (most are usually debt-free), and even after paying off their liabilities, the company still has a cash balance which even surpasses the company's market capitalisation. On that basis, the company can theoretically purchase all its outstanding shares with its cash holdings, leaving the management with full ownership of the company at no additional cost. Now why have we not seen this happening?

A 5 Jan 2010 announcement by one of the S-Chips (China Milk) may offer some clues:

"The Board wishes to advise that the Company is still currently awaiting clearance from the State Administration of Foreign Exchange (“SAFE”) of the People’s Republic of China (the “PRC”) for the remittance out of the PRC of approximately US$170.56 million, being for the full settlement of the Early Redemption at the Option of the Bondholders (including interest). The Company believes the delay is administrative and procedural in nature and there is no legal obstacle to the remittance of the same.
China Milk was in default of its convertible debt obligations to the tune of approximately US$146 million in early 2010, and with the company yet to resolve this issue, the stock still remains suspended today. The company had a rather strong balance sheet, with sufficient cash to repay its impending puttable debt obligation. The company's bonds even traded above par prior to the default, suggesting that investors believed the company would be able to redeem the bonds.

However, facing remittance issues, China Milk has yet to settle payment with bondholders, which sends a strong message to investors who are looking for S-Chips which appear cheap based on their balance sheets. The cost (and difficulties) faced with remittance of cash held offshore may mean that cash balances on balance sheets are not what they seem. Some of this cash balances may never be able to fund a share buyback programme, or a hefty dividend payout. Sometimes, a dollar in hand (or in this case, held onshore) may be worth more than two in a bush.

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