In looking for data this week on how American businesses use their cash, to confirm the observations of a longtime Minneapolis portfolio manager interviewed for an upcoming column, I reviewed the most recent look at cash flow produced by The Georgia Tech – Scheller College of Business.
The authors have a broad enough view to produce a regular report on cash flow that’s far more interesting than might be suggested by the title “Cash Flow Trends and Their Fundamental Drivers.”
The authors are looking at the cash flow data of 3,000 or so companies that have a market capitalization in excess of $50 million. The focus of their study is “free cash flow,” which is the cash profits left over after all obligations have been paid.
It’s truly “free,” meaning the company can use it to make acquisitions, invest in capital items like new stores or increase the dividends to shareholders.
The most recent report has data back to 2000. While the numbers from quarter to quarter bump around a little, and it’s easy to see impact of the Great Recession in several charts, there are long-term trends that are very striking.
One is that cash and short-term investments, usually shorthanded as simply “cash” when investors and columnists write about corporate finance, just continues to steadily mount. The median amount is about $88 million, up from just over $30 million 14 years ago.
What explains that?
Well, one other long-term trend is the shortening of the cash cycle, measured in days. This basically is keeping track of the money tied up in inventory and receivables, after subtracting the bills the company has paid yet. And it’s down from over 60 days in 2000 to less than 50 days in 2014.
Another is the decline of capital expenditures, the investments companies make in capital items like buildings or new computer technology. It was around 5 percent of revenue early the last decade, and most recently declined to less than 3.5 percent of revenue.
Capital spending, of course, rolled off the table in the Great Recession and did not recover all the way to prerecession levels, but it had been declining before the start of the last big downturn.
The way to summarize this is that American companies have increasingly figured out how to own fewer assets other than just cash. They might now outsource manufacturing, and thus don’t need a big assembly plant. They may drive more sales through e-commerce channels rather than open more physical stores. And they are a lot savvier about limiting inventories.
One way to look at this is that it’s great that American companies became more efficient with capital, and they should be able to return more capital to shareholders in the form of share buybacks and dividends.
Then there is a contrary view, that American business managers remain excessively cautious and focused on short-term profitability. They would much rather let cash balances build than invest in new technologies or new physical assets. And this can’t be a healthy thing for the economy over the longer term.
In talking about MNsure in the last week, one of my go-to guys in the health insurance market tried to once again explain the continuing hostility toward MNsure on the part of a large slice of the public as well as many health benefits brokers and others in the market.
It’s fundamentally opposition to its very existence and really not criticism of its effectiveness or doubts about the intentions of the people now in charge.
MNsure was created as an online marketplace in Minnesota for those seeking to purchase health insurance who might be eligible for subsidies under the Affordable Care Act. States had the option to proceed with such an exchange or have everyone go to a federal exchange.
For MNsure critics, the issue is that MNsure is an artificial market, created by the state, and people who are eligible for subsidies for their health insurance costs have no choice but to use it.
They say there had to have been a better way, leaning on the private sector, to achieve the policy goal of enabling a subsidy to reduce the number of uninsured people.
As my expert pointed out, folks eligible for the Supplemental Nutrition Assistance Program, or SNAP, usually get an electronic benefit card. They can take that into Target, Cub or Coborn's to shop for groceries.
Imagine, he said, if the MNsure model came to food, and the state made everybody eligible for SNAP go to MNgrocer.
There would be an uproar, and not just because it’s a grocery store located in an industrial area of St. Paul that’s not easy to reach from public transit, or it may not have fresh milk that day.
The irritating part would be that participants on their way to MNgrocer would pass a Target or Cub that is perfectly able to meet their needs – with fresh milk that’s competitively priced.
There has been plenty of media coverage of the capital gains tax facing Medtronic shareholders when the company’s proposed acquisition of Covidien closes.
The structure of the transaction is an inversion, which triggers a capital gains tax for holders of Medtronic when they exchange their shares for shares of the newly merged Irish company, Medtronic PLC.
One aspect of this tax that has not been deeply explored is how it blows up the estate plans of lots of Medtronic shareholders, many of them retirees from the company. It has the effect of creating a tax, consuming a bunch of their family’s wealth, when they had a perfectly legal plan to never let their Medtronic stock gains get taxed.
The basic principle at work here is what’s called a stepped-up basis. Under the federal tax laws, there is an exclusion from estate taxes of a certain amount of assets when a person dies. Under current federal law, it is more than $5 million, and twice that if it’s a married couple that manages its affairs well.
When an estate files its tax return, the assets of the estate are valued at fair market value. In the case of a publicly traded stock like Medtronic, that’s just a matter of looking it up on Bloomberg and filling in the form, and today it’s around $64 per share.
When the heir takes possession of the stock, that $64 is her historical cost, her “basis,” even though Dad may have had an average cost of $10 per share. That’s what’s meant by a stepped-up basis.
So, by dying with the shares in his estate, Dad effectively transferred $54 per share of gain to his daughter in a way that’s never going to be taxed. His daughter can sell it today at $64, with no taxable gain.
How many individual Medtronic shareholders had exactly that in mind for their Medtronic shares? Impossible to say, but the guess here is that it was a lot of them.
That’s no longer possible, not unless Dad and Mom manage to die between now and when the transaction closes.
So when you meet the Medtronic shareholder in their golden years who sounds very crabby about the pending transaction with Covidien, please understand that a simple plan to leave some wealth for the kids just took up to a 30 percent hit.
A great paper for the Labor Day weekend, if you have the time and stomach for it, is MIT economist David Autor’s latest work on machines’ ability to take our jobs.
Called “Polanyi’s Paradox and the Shape of Employment Growth,” the paper starts with the quote from the philosopher Michael Polanyi who famously observed that “we can know more than we can tell.”
It’s this idea, that we can do complex jobs that we really don’t fully understand, that lies at the heart of the argument that computers and robots will never successfully replace human labor.
What’s interesting is that the quote also refers to the irreplaceable art of driving a car -- we are good at it even though we may not understand the physics or engineering of our vehicle. A machine-driven car in 1966 seemed beyond the wildest forecast of machine capability, of course, but thanks to Google we know it’s coming, likely in most of our lifetimes.
Autor, however, is mostly an optimist about the ability of humans to hang in there in the labor market. The computers haven’t been able to do the jobs that require non-routine work, at both ends of the income spectrum. As he put it, “the challenges to substituting machines for workers in tasks requiring adaptability, common sense and creativity remain immense.”
In one great example, he writes it is relatively easy to come up with the machine that can recognize shapes and patterns, but a machine isn’t going to as easily understand what an object is for. Meanwhile, a person looking for a chair will quickly reject the toilet and a traffic cone that, to a computer, might both look suitable for sitting.
His implied advice is that people looking for skills and good employment prospects need to think of jobs that are complemented by computers, and he's not just writing about jobs in management or the top professions.
While many middle-skill jobs do have tasks that can be easily automated, to do them well a person needs a broad range of skills. It’s not that easy to unbundle a job and assign to a computer just the specific, repetitive tasks that lend themselves to automation.
An example he uses is calling software tech support. A computer might search the databases for known issues that seem to be the customer’s problem while the technician politely chats up the customer on the phone. When a solution is located, the technician can read back what the computer found.
Yet that is not a very productive form of labor organization, he wrote, making it possible for jobs to persist with routine and nonroutine aspects are complementary. Back to the example of tech support, the technical expertise has the most value when it comes from a person who has the judgment to help the customer figure out what’s wrong and can talk her through the best solution.
All of which is to suggest, he concluded, that the pessimists about the future of human work are overstating their case. It also means, thankfully, that we can look forward to many more Labor Day weekends.
The quarterly client newsletter from Perkins Capital Management was eagerly anticipated because, from an exchange of email, it was clear that founder and patriarch Richard “Perk” Perkins was going to address the Medtronic-Covidien tax inversion deal.
The transaction, a stock and cash deal that valued Covidien at over $93 per share, is also taxable for shareholders of both companies. This was a surprise to many longtime Medtronic shareholders, including Perkins, who have seen Medtronic acquire numerous companies before with no such tax.
The tax savings and balance sheet flexibility to be achieved by relocating to Ireland “all sounds great at first blush, and maybe it is in terms of creating long-term value, but it gives many Medtronic shareholders apoplexy in the form of a large tax bite, because the exchange of Medtronic shares for new Medtronic PLC shares is a taxable event,” he wrote.
“This is especially hard for Minnesota shareholders as Minnesota does not distinguish between long-term and short-term gains and, worse, all capital gains are the same as ordinary income for tax purposes. Therefore, a Minnesota resident could pay as much as 30 percent in combined federal and state tax on this exchange.”
The interesting thing here is a Perkins does not blame the company’s management or board for creating this taxable event, as the case for going ahead with a corporate inversion is such a strong one.
In this newsletter, he reprinted a chart produced by the Tax Foundation that ranked all 34 nations in the Organization for Economic Co-operation and Development by statutory corporate income tax rate.
At the top, at 12.5 percent, is Ireland, one day soon the home of Medtronic PLC. At the very bottom is the United States, with the highest corporate income tax rate of over 39 percent, considering also the effect of state taxes.
The average rate is 25 percent, and many of the countries with below average rates are less wealthy and so the effort by their policy makers to attract and retain businesses is at least understandable.
It’s also striking to see countries like Sweden and the United Kingdom, which are perceived to be high tax places, charging not only far less than the U.S. but also below the average of all these countries.
Unless and until Congress acts to lower the relative U.S. corporate income tax rate, Perkins wrote, expect the corporate inversions to continue.
It’s coming down to the wire on the vote for the board members at ValueVision Media, and one of the most interesting questions is whether the decisive votes will be cast by somebody who maybe shouldn’t even vote – Comcast Corp., the cable TV giant.
ValueVision is also in the TV business, of course, as a TV shopping retailer. It’s had a long history with NBC, and until recently its shopping channels were known as ShopNBC.
Comcast acquired the relationship with ValueVision in its two-step purchase of NBC from General Electric. As of the last report, Comcast owned about 14.3 percent of the outstanding common stock of Eden Prairie-based ValueVision. GE remains in the relationship as well.
The activist campaign of Clinton Group to oust the board has been going on for months. Only shareholders with an appetite for tedium could have gotten through every page of all the filings.
Clinton’s effort now presents a choice for Comcast, although it is no ordinary shareholder. Through a shareholder agreement it has rights other shareholders do not have and has a cable distribution agreement with ValueVision to carry its shows.
It is very difficult, if not impossible, to imagine a scenario in which Comcast decides it has to vote to oust the board. It’s in business with ValueVision. It's has had executives on the ValueVision board during the tenure of the CEO Clinton Group has said also needs to go.
It would be more than a vote against a partner; it would be a vote against itself.
Oddly, however, voting for the incumbents also doesn’t seem to be a comfortable choice. Comcast has a distribution agreement with ValueVision. It gets paid to carry the company’s shows. And the activist campaign is about the performance of the company over time, which Comcast may not care to be seen as defending.
The best option may be to abstain.
How Comcast votes won’t be disclosed -- although it’ll probably be apparent if more than 7 million shares show up in the abstention column.