Yeah, I Occasionally Do Homework

I've been meaning to post this for a while, it's a memo I wrote for one of my classes here. The class is called "Managing & Leading Organizations", it's taught by the only non-PhD professor we've had in the program thus far and even though there's no PhD, the wealth of real-world knowledge is so exceptional I don't think it matters. Anywho, about this memo, throughout the class we're supposed to write ten memos about current events and discuss the implications for an organization. In the following memo, I'm assuming I'm writing to a manager of a corporate treasury/CFO-type individual and I think the implications, while not explicit, speak for themselves:

"I am writing to inform you of a recent conflagration of events and occurrences that may have widespread implications for global M&A activity into the near future. Given recent corporate proclivity to hold excess cash ($1.84 trillion in cash and marketable securities on non-financial corporate balance sheets) and worldwide investors insatiable demand for bonds it seems many companies, especially those under pressure to deliver results to shareholders, will derive lofty valuations for firms they seek to acquire.

As evidence for the insatiable demand of bonds, I will present the results of two recent debt offerings, one by McDonald’s (NYSE: MCD), and another by Norfolk Southern (NYSE: NSC). Late this July, MCD issued $450mil of 10-year notes and $300mil of 30-year bonds. The 10-year notes were issued with a yield of 3.5%, matching the lowest 10-year rate for all US issuers in 15 years, the 30-year notes (issued at 4.875%) matched an all-time low mark set recently by Wal-Mart. In addition, NSC recently issued what has been termed “century” bonds. These bonds, as the name indicates, will not pay back their principal until 2110, a time at which (likely) all current purchasers will have ceased to be living. NSC initially planned to sell only $100mil of these bonds, but prior to announcing the quantity of the deal, investors expressed interest in at least $75mil, the issuance was then raised to $250mil and was still oversubscribed. This oversubscription and the competitive bidding process for the paper led to the bonds selling above par (6%), and with a yield-to-maturity of 5.95%. While very few assets can have a lifespan of 100 years and thus will not be able to match the lifespan of the liability, I will offer a short defense of the century bond. If (and this will likely not be the case) the coming hundred years is analogous to the last hundred years, the present value of the $250mil principal payment in 2110 is currently nominally worth approximately $13mil, which is $2mil less than the real annual coupon payment.

This ability to acquire cheap cash could lead to an expansion of worldwide M&A deals. While above I state this cheap cash will lead to expensive acquisitions, I believe this has already begun and should serve as a cautionary tale to executives thinking about expanding through acquisitions. Recently, there have been three large acquisitions or attempted acquisitions that have occurred. Intel recently acquired McAfee virus protection in an all-cash deal and publicly stated the deal “will not significantly contribute to next year’s income”, seemingly fitting the bill of an expensive acquisition. Additionally, HP and Dell are currently locked in a bidding war for the data storage company 3Par, with the most recent bid nearly double the initial offer. And this acquisition spree is not limited to tech firms, with Australian mining giant BHP Billiton having recently taken a $130/share offer directly to the shareholders in an attempt to win control of the Canadian fertilizer miner Potash of Saskatchewan, this $130/share offer has been rejected by management as being too low and the company is currently searching for a “white knight” with several sovereign wealth funds being considered as potential bidders in addition to BHP. Companies that may or may not be on the prowl for acquisitions in the near future include Apple and Cisco, both with net cash positions of at least $25bil."

I wrote the memo about two weeks ago and some changes have already taken place, just a couple days ago Cisco announced they would be returning some of their large cash pool to shareholders through a dividend. Of the two main methods of returning capital to shareholders, dividends are the method I least like, but it's a good start and that's a discussion for another day. If you (my reader, singular) have any questions about that writing, or any other questions about classes here at Walton, let me know, I do take blog requests. Also, sometime on the horizon, I'll be having a guest blogger (the Czar) do a post for a little different perspective on the program.