Cash Repatriation in the New Administration - Opportunities and Challenges
President Donald Trump’s campaign promise to create incentives for U.S. companies to repatriate offshore cash balances by offering a reduced tax rate on repatriated funds is focusing the attention of companies and investors on capital allocation. For those companies with significant cash held overseas, it is critical to develop a plan to navigate this potential opportunity in a way that is consistent with your company’s business strategy, takes into account the increasingly divergent views of investors and allows your company to respond decisively when specific policies are disclosed and enacted.
Changes in Governance and Investor Interest in Capital Allocation – 2004 to Today
Since the last tax-advantaged cash repatriation opportunity in 2004, there have been significant changes in the shareholder landscape. The migration from actively-managed funds to index funds has concentrated company ownership and a more active governance community is increasingly focused on key strategic decisions such as capital allocation.
For example, in late January, BlackRock Chairman and CEO Larry Fink wrote in his annual letter to CEOs:
If tax reform also includes some form of reduced taxation for repatriation of cash trapped overseas, BlackRock will be looking to companies’ strategic frameworks for an explanation of whether they will bring cash back to the U.S., and if so, how they plan to use it. Will it be used simply for more share buybacks? Or is it a part of a capital plan that appropriately balances returning capital to shareholders with prudently investing for future growth?
Boards are engaging frequently with institutional investors who are interested in understanding how directors oversee the capital allocation decision-making process. If a tax repatriation window opens, long-term shareholders would look to companies to carefully consider and balance investment in the business, share buybacks, regular dividends and acquisitions with an eye to allocating capital in a way that maximizes sustainable long-term returns. Investors with shorter-term horizons, notably some activist investors, may favor short-term solutions such as large-scale share buybacks and special dividends at the expense of other options.
In the face of this tension, the defining capital allocation challenge in 2017 will be in implementing and effectively communicating a company’s rigorous decision-making process at the board and management levels.
Opportunities and Challenges
Each of the options in allocating newly-repatriated capital present unique challenges around which companies need to be able to effectively communicate their rationale and decision-making process:
• Reinvest to drive organic growth – Reinvestment is a priority for companies, and long-term investors tend to favor organic earnings growth over riskier acquisition strategies. However, investors want to see favorable returns on capital investment, and if a company’s business model is disadvantaged relative to its competitors, faces a permanently declining customer base or is limited in its organic growth opportunities, reinvestment may not be the best use of capital.
• Pay a regular or special dividend – A one-time cash repatriation is unlikely to result in a long-term regular dividend increase. However, although special dividends are in some ways a flexible and efficient way of returning cash to shareholders, their use is unfamiliar to many management teams and some investors may engage in short-term trading strategies around dividend payout dates.
• Deploy cash for share repurchases – If executed properly, share repurchases can generate attractive returns on capital. However, broadly speaking, this option is less attractive in the current market environment as stock prices have risen and valuation multiples have expanded over the past several years. In addition, this practice has recently received greater scrutiny from governance teams at institutional investors who see buybacks as creating potential short-term benefits that might sacrifice long-term value creation, particularly if the buybacks help executives meet performance goals. Repurchases at elevated stock prices have also served as a lightning rod for activists if the company subsequently encounters challenges.
• Pay down debt – In addition to not being an option for companies with low leverage, paying down debt may be an unattractive option due to the persistently low interest rate environment. In certain sectors, such as technology, companies may have already borrowed funds against their overseas cash balance and essentially pre-deployed it. In these instances, using some of the repatriated cash to pay down debt may be an option worth exploring.
• Make acquisitions – Current valuations of target companies may not be attractive, which increases the degree of difficulty in executing an inherently risky strategy. However, to the extent that a company is able to make a clear and convincing case that a transaction has strategic merit and will drive attractive returns on capital relative to the company’s cost of capital, investors are very willing to engage with management and board teams to understand their rationale.
• Take no immediate action – While it may be the right strategy to take a patient approach to deploying capital, large cash balances tend to attract the attention of activist investors.
Effective Communication is Critical
If a cash repatriation window becomes a reality, impacted companies will be under the microscope. To meet this challenge, boards and management teams need to adhere to a disciplined and well-defined capital allocation process and develop an effective, transparent strategy to engage and communicate with shareholders. Investors will be particularly focused on board oversight of this process and how the chosen course of action is expected to create value for long-term shareholders.
Staying ahead of the impact of potential tax reform and other material shifts in the political and economic landscape will require a thoughtful and well-coordinated engagement effort. Companies that wait to begin communicating with investors when, or if, political promises become political realities are missing an opportunity to productively engage with shareholders who are invested in their long-term success.
About CamberView Partners
CamberView Partners is the leading provider of investor-led advice to public companies on engagement and shareholder relations, activism and contested situations, sustainability and complex corporate governance matters. CamberView helps its clients succeed by providing unique insight into investors’ perspectives on long-term value creation, interpreting the evolving governance landscape and creating proactive strategies to stay ahead of investor challenges.
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Abe M. Friedman