Tuesday, October 21, 2008

Memo to Google: Don't “Grow Up”



Google's Cash Conundrum: Too Much

Could Google provide a stimulus package to help boost the ailing U.S. economy?

Google CEO Eric Schmidt revealed Monday to The Wall Street Journal that the company is "thinking" about returning cash to shareholders. It's only a concept at this point, mind you: Mr. Schmidt ruled out a dividend and said no cash return was likely anytime soon.

—The Wall Street Journal, October 21, 2008


Did Eric Schmidt learn nothing this year?

And does the Wall Street Journal not pay attention to the very headlines it has been writing these last few liquidity-deprived months?

Could it be that a single weekend without five or six bank failures around the globe has blocked out the memory of five or six months’ worth of round-the-clock meetings involving sleep-deprived Treasury officials crafting rescue packages for every major investment bank—save the one that filed Chapter 11—in America?

Did we miss something, or did Team Iceland—by losing all three of its banks in one week—not just bat 1.000 in the Bank Failure World Series?

Was this whole crisis all a dream?

Apparently it was, because the above-quoted Wall Street Journal article provides a circa 2005-2006 take on the miseries of a publicly traded corporation with too much cash:

Google's growth and love of experimentation is not over. But, on the financial front, it may be growing up.

If “growing up” means throwing away cash on the kind of mindless, investment banker-enriching share buybacks and special dividends that Dean Foods, Scott’s Miracle-Gro, Office Depot and many others embarked on at precisely the wrong time, financial-crisis-wise, we vote for Google remaining a strapping youth.

Readers may recall the “growing up” of Office Depot CEO Steve Odland, who “cleared the balance sheet” of nearly $1 billion in cash in fiscal 2006, buying 26 million shares of Office Depot at an average price of $37. (See
The Shareholder Letter You Should, But Won’t, Be Reading Next Spring,” from August 08, 2007 and “Attention Target Management: Pay No Attention to Analysts Begging for Buybacks,” from November 21, 2007).

Odland’s move earned kudos from Wall Street’s Finest and temporarily provided a lift to the stock price of a second-string office products distributor, but it did nothing to turn Office Depot into a first-string office products distributor, nor did it prepare the company for whatever the world's economy could throw at it: the stock could be bought yesterday at $2.85 a share.

Thus it was with some shock we read the following about Google’s supposed interest in the same sort of “cash-clearing” exercise that crippled more than a few companies at precisely the moment they could least afford being crippled:

Even so, it was a telling comment, indicating that despite Google's continued investment in a range of new business initiatives and infrastructure, the company's cash is piling up faster than it can be spent. On Sept. 30, Google had $14.4 billion in cash and marketable securities.

It may also signal that management is concerned about the roughly 50% fall in Google's stock price over the past 12 months.

We have never seen a company—particularly a supposed high-growth enterprise such as Google—that has successfully propped up its stock in any other way than by continuing to grow its business in a rational, sustainable manner.

And that includes especially the kind of “cash-clearing” follies that helped bring Office Depot from $37 a share to less than $3 in a few short years, and paralyzed hundreds of other companies that might otherwise have taken advantage of cheap prices in the current liquidity squeeze, while forcing the least healthy to seek shotgun mergers or worse.

If a lesson is to be learned from the last three months, it is that cash is not 'trash,' as the saying goes: it is a valuable strategic asset that gives a company an enormous leg up when its competitors have had their legs cut out from underneath them.

Just ask Steve Odland, Eric.


Jeff Matthews
I Am Not Making This Up


© 2008 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.

13 comments:

Reginald said...

The best solution is a reasonable quarterly dividend, which leaves the company with the same cash hoard. Buybacks mostly remove shares issued in stock options for management. Companies that pay sustainable dividends have seen their stocks dive, but not to the same extent as others that pay no dividends.

Lyon Jewett said...

If what Jeff just wrote isn't a good indicator of things to come for these guys I don't know what is.

Anonymous said...

Well said Jeff. Looking back, it really exposes what management teams were NOT good allocators of capital and who DID give into the institutional imperitive to maximize shareholder value. Immatator activist hedgfunds pushed them along to do so...go for them I guess, however rarely did I see a activist position do more good than harm (Pirate Capital to name one..). That said, what made so many companies so attractive to Ben Graham and WB post depression WAS the fact that they horded cash, which was acceptable to the investing public due back then due to the impact of the Great Depression, Hence they were able to buy companies at .40c on the dollar...My question then is, are we at the beginning stage of that hord and acceptance? P.S. You were a great speaker at the Value Congress in NYC..."GE; What did Warren Buffett do/did?" Good luck with the book, I look forward to reading it before my first pilgramidge this May!

Jeff Matthews said...

Much thanks.

JM

Anonymous said...

Cash on the balance sheet may be more valuable than it appears at first glance due to the flexibility it gives management, especially in times of crisis. Real options have value, and you could argue that having cash in times of crisis is like a real option.

And obviously, buying back shares at a premium hurts long term shareholders and destroys value in the same way greenmail did in the 1980's.

The last time I checked, Google was continuing to grow and steal market share away from Yahoo!. The company is hardly mature, at least if you base it off of their most recent earnings call. Shares may finally becoming reasonably priced, and dare I say it attractively valued . You no longer have to pay up as much for the company's growth, which I refuse to pay for.

Tsachy Mishal said...

I could not disagree more. You are comparing apples to oranges. The companies mentioned got in trouble because they borrowed money to buy back stock. Google has no debt and they can buy back stock and still have tons of cash left over. Generally, buybacks don't benefit high growth companies because they are buying back stock at 40 times earnings. However, if Google can buy back stock at 15 times earnings I believe it would be advantageous, especially if they can keep up their growth.

Marc O'sullivan said...

For the past two years, Google have been walking the fine line in their communication strategy: bundling their 800-Pound Guerrilla conduct while maintaining their start-up mentality. The same set of mind that made Google > Google.
These "thinking" about returning cash to shareholders seem to be a result of that tension.

Anonymous said...

Jeff,
If the cardinal rule is to enrich the shareholder would not a dollar in the hand right now be better than dollars on the balance sheet while the stock has still declined by 50%?? if they want to pay out cash to the owners of the company instead of trying to buy companies that may not be profitable let them, it is what any small business does.

Jeff Matthews said...

Anonymous:

This "enrich the shareholders" nonsense has been spouted by management with underwater stock options at the behest of investment bankers who wanted to do deals, period.

Yahoo spent $5 billion "enriching shareholders" via stock buybacks the last 3 years...and what they did was disinvest in their business and lose their lead to Google.

If Yahoo hadn't been so focused on "returning value to shareholders" by throwing away $5 billion on a fad, they might have found a way to compete with Google.

"We have dry powder and a loaded gun," Buffett has been telling shareholders for several years. These days he's been using it to the shareholders' future enrichment.

Why should Google dribble away its dry powder on nothing but a fancy way to keep the stock chart from breaking down?

Of course, I could be wrong. But show me one company that today is glad it spent its cash "returning value to shareholders" during the easy credit years instead of keeping that cash for the day when bargains galore are out there nobody else has the ability to do it.

My two cents.

JM

Anonymous said...

I agree with you JM. Remember when Domino's Pizza (DPZ)did its special dividend back in May 2007? Right before fire was yelled in the room at Bear Stearns in June/July of 2007, near the very top.

If I recall the transaction was basically a recapitalization and DPZ took on a lot of debt (about $1B). This wasn't a stock buy back, of course, but the same thought process went into the recap here in my view, and the "returning value to shareholders" line appeared somewhere in the process. How I bet DPZ would love to still have that cash today.

Of course, returning cash to shareholders isn't always a bad thing, it just depends on the circumstance and its something that requires judgment. At the end of the day, there are no hard and fast rules, just common sense.

ajr3x said...

Jeff,

I don't completely disagree with you, but I'm not sure the share repurchase decision is so black & white.

The way I look at it is if mgmt can buy back stock - without risking the balance sheet - at prices well below a conservative estimate of intrinsic value, then they should consider that option.

However, they should weigh the potential returns on those share repurchases (as measured by the upside from repurchase price to estimated intrinsic value) against alternative options, such as cheap acquisitions, investment in new growth opportunities, dividends, etc.

Leon Cooperman gave a good presentation at last year's Value Investing Congress on Teledyne's founder and former CEO (Dr. Henry Singleton, I believe) and his knack for doing tenders and buybacks at very opportune times. He ended up creating significant value for his shareholders by periodically buying back his stock at cheap prices over several decades. I think Teledyne's shares' CAGR during his 35-yr tenure was something like 23%.

Of course, this method requires a keen "feel" for intrinsic value and prudence to not take the process too far up the risk curve. Still, great managers should know their own business and its long-term prospects better than they're likely able to assess the prospects of another business they might consider acquiring. If they can combine that knowledge with an ability to estimate intrinsic value then I think they could be strong capital allocators.

I totally agree that there were downright stupid share repurchases done at stupid prices in recent years...especially those funded with extreme leverage added to the balance sheet, a la private equity's approach.

That said, it seems managers with good businesses with a reasonable degree of predictability/non-cylicality should at least consider buying back stock as one of their capital investment options...especially if their shares trade at a deep discount to a conservative estimate of intrinsic value, they have excess cash, and they continue to generate significant free cash flow.

As for Google, I have no firm opinion on how it should allocate capital b/c I don't know the business that well.

Love the blog and just received your book from Amazon. Looking forward to reading it.

Anonymous said...

Wait a minute, isn't it the ultimate return of cash to shareholders that determines their returns? the question is, what can Google do with its cash, if it can "add value" (an admittedly imprecise concept) by retaining it/spending it, fine. However, your analysis ignores the other way managements love to destroy value: bad acquisitions. So let's take a look: in all the things Google has done beyond its core search efforts, how much value have they added? Do we think they will be superior buyers of other guys' businesses? if so, fine, but if we question that (as i do), then a program of returning excess cash to shreholders is a far better plan.

Jeff Matthews said...

ajr3x:

I agree that there are circumstances which arise in the course of a company's life when share repurchases below intrinsic value are the best use of cash.

And, as 'anonymous' points out, some acquisitions (many acquisitions, actually) can be quite poor uses of cash, and that the notion of returning cash to shareholders is not a mere fad, but the fundamental premise of capital markets.

My issue is with this knee-jerk, "return value to shareholders" sweepstakes that so many companies joined in, and have been crippled by, in the last five years.

If Google's CEO had said, "You know, our stock price makes no sense; we can get a better return on our cash by buying stock than we can in CDs; and we have no forseeable need for major acquisitions, so we're buying," then I'd say it's probably the right thing to do.

But what I heard him say was something to the effect of, "Our stock is down and we have millions of options under water...but we have lots of cash, and maybe we could return value to shareholders and also support the stock price and make those poor shlubs who own all those worthless options feel a little better by doing something."

And that's a poor reason to dilute one of the strongest balance sheets in corporate America.

Of course, that might not be what he meant to say.

JM