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Awash in Cash _ Management Problem: Reinvest High Profits Or Please Institutions?

October 16, 1995

Many executives who run America’s large corporations are at a crossroads. With profits high, they must decide what to do with all the cash now flowing in. Plow it into the business? Or please many shareholders, perhaps by buying back stock?

As earnings momentum slows, more and more executives will be wrestling with that seemingly enviable question _ and finding a decision difficult. At General Signal Corp., they already are.

``We have a full plate of what to do with our money, including paying down debt from acquisitions,″ says Nino Fernandez, head of investor relations at the electronics-equipment maker. But the stock of the Stamford, Conn., company took a dive recently, to about $29 a share from $35, after management said second-half profit growth wouldn’t be as robust as analysts had predicted.

Lately, several big shareholders have begun urging General Signal to divert cash from paying down debt, as management prefers, to propping up the stock. A popular, though expensive, way to bolster the price is to repurchase shares on the open market _ thus reducing the supply and, by spreading profits over fewer shares, enabling per-share earnings to increase faster than total net income.

A lot is riding on such decisions. If many companies carry out big buybacks, the reduction in shares outstanding could buoy stock prices in the short run. But it could prove costly in the long run if, as some companies say, they thereby lose their painfully acquired competitive edge in world markets.

Indeed, some Wall Street analysts applaud the major long-term investments made by many U.S. companies and regard any retreat as a strategic mistake. ``This is a golden opportunity to invest in the infrastructure to pursue faster-growing markets in other parts of the world,″ says Jack Kirnan, an auto analyst at Salomon Brothers. ``It would be ironic if short-sighted institutional investors prevented them from doing so.″

Also ironic: Corporate executives themselves are partly to blame for big investors’ narrow focus. They demand that their pension-fund managers turn in results at least matching the market averages.

Some executives have already resisted pressure for a buyback and have seen the stock price rise anyway. One is Glen Hiner, chief executive of Owens-Corning Fiberglas Corp., of Toledo, Ohio. Last year, when Owens-Corning stock was trading at about $36 a share, one of the company’s largest institutional investors told him that that wasn’t high enough.

``We had a long and hard discussion about why I wouldn’t buy back stock and why I thought my plans were a better way of increasing shareholder value,″ Mr. Hiner says. The investor sold out, but on Friday the stock closed at $44.75.

Nonetheless, securities analysts and large shareholders can advance some compelling arguments that go beyond merely chucking the long-term view to satisfy the desire for rising stock prices and profits here and now.

``More and more institutional investors think the best use of the money is for companies to put it into their own shares,″ says Michael Metz, director of research at Oppenheimer & Co. Recent history warns institutions, he adds, not to let companies ``go on egomaniacal empire-building or binges of spending for overcapacity.″ So, the investors push for buybacks even though many executives pledge to avoid past corporate mistakes.

Diminishing prospects for strong economic growth and for safe investment alternatives generate ``more pressure on companies to buy back their own stock,″ Mr. Metz says. Many analysts expect slowdowns in earnings gains to begin with third-quarter reports. The net income of the 500 large companies in the Standard & Poor’s index climbed 24 percent in 1992, 21 percent in 1993 and 22.5 percent in 1995, but analysts expect growth to slow to 18.3 percent this year and 14.5 percent next year, according to Zacks International, a Chicago firm that tracks Wall Street estimates.

And as growth slows while cash flow remains high, Wall Street’s calls for buybacks are picking up. Repurchase announcements this year have soared to a record $72.5 billion, already surpassing the $69 billion in all of last year. But typically companies don’t say when the buybacks will occur, only that they are planned over the next several years. And they frequently don’t occur fast enough to please big stockholders.

In recent weeks, Champion International Corp. bought 325,000 shares in a five-million-share repurchase plan announced in late August. But the papermaker’s stock has fallen from a record $60.25 on concern about slowing earnings gains; it now trades around $54. And several large holders urge Champion to step up its buybacks because they consider the shares currently undervalued. One money manager wants it to divert incoming cash from paying down debt to buying in stock. ``It’s a better return for shareholders than saving 4 percent after tax on debtinterest expense,″ he says.

But Champion is resisting. Frank Kneisel, its senior vice president for finance, says he tells shareholders, ``Look, let us continue to get our debt paid down, and then we will consider buying back more shares.″ He notes that the company already is on pace to buy back a total of one million shares by year end, using cash that could have gone to increase the dividend.

Bondholders also have a clear interest in persuading companies to pursue debt reduction. Several weeks ago, Moody’s Investors Service downgraded Hershey Foods Corp.’s long-term bond rating, citing ``the impact of Hershey’s recent debt-financed stock repurchase (totaling $500 million) on its financial flexibility, as well as its appetite for further share repurchases.″ Hershey declines to comment, other than to note that Standard & Poor’s recently reaffirmed its rating.

Also under the gun to buy back shares are the auto makers. Chrysler Corp. twice announced buybacks of $1 billion each this year, the second after investor Kirk Kerkorian tried to buy the company largely with its own $6.4 billion cash hoard. Ford Motor Co., whose cash jumped to $4.8 billion at Dec. 31 from $718 million at the end of 1992, and General Motors Corp. have so far refrained from new buybacks; they want huge reserves to weather the next business downturn, analysts say.


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