Commentary July 8, 2010, 2:00PM EST

Investing: When Cash Takes a Vacation

(page 3 of 3)

Grant points to Darden Restaurants (DRI), which runs the Olive Garden and Red Lobster chains. He notes its 25 percent return on equity and 2.3 percent dividend yield. Darden holds more cash on its books than it knows what to do with: $249 million as of May, a quadrupling over the same period last year. On June 23 the company goosed its dividend by nearly a third, to 3.1 percent. Yet the stock is still some 22 percent off its year's high. Investors are not impressed—at least not yet.

Or witness how Pfizer (PFE), the acquisitive megapharmaceutical behind the Lipitor and Viagra brands, yields 5 percent to no apparent avail: Its shares are near their low for the year. In downgrading the stock in late June, Goldman Sachs said management was not taking enough shareholder-friendly action to unlock embedded value (Goldman recommended a sizable dividend increase). Indeed, last year Pfizer cut its dividend to help fund its $68 billion purchase of Wyeth. One thousand shares of Pfizer bought 10 years ago would now be $29,115 underwater—$23,638 when factoring in the dividends it has since paid out. The drugmaker, which now has $26 billion in cash on hand, is practically inviting a long-suffering institutional shareholder to try to shake loose its cash.

Unfortunately, shareholder activists are still smarting from the agitations that were all the rage during the bull run of 2003-2007. In 2006, activist Carl Icahn prevailed upon Time Warner (TWX) to buy back $20 billion in stock that has since fallen 22 percent. Bill Ackman similarly prodded Target (TGT) to pay too much for its shares in a campaign that the discount retailer ultimately had to scotch to conserve cash. The epic tide of dividend cuts in 2008 and 2009 further soured investors on the efficacy of unlocking excess balance-sheet cash.

Sylvan Chackman, global co-head of prime brokerage at Bank of America (BAC), says he expects hedge funds to stir this quarter. "They need to put their capital to work to generate returns," he says. About 48percent of the 2,000 hedge funds in the HFRI Fund Weighted Composite Index are still below their so-called high-water marks. Until they return to that critical threshold, they are unable to charge investors performance fees. Stay in the hole long enough, and you might as well close up and start anew elsewhere.

Those hedge funds that do plan to stick around, however, will need a story, a game plan, a lever to pull—especially if we really are on the precipice of a chronically bad time for market returns. When it becomes clear that every point of return matters, fund managers will fight to wrest back every dollar of excess cash from their portfolio companies. There will be open letters, moral and immoral suasion, proxy battles galore.

And there should be, because CEO vanity springs eternal. Consider Eastman Kodak (EK), which blew upward of $15 billion on abortive acquisitions and product development in the 1980s and 1990s as its core film business shriveled. The whole company is now worth just $1 billion; wouldn't shareholders have preferred to get some of that $15 billion back? The obverse of that example is a company that also reinvested, ignoring an archrival's taunt that it should close shop and give its money back to shareholders. That company is Apple (APPL), and the problem today is that every chief executive officer wants to be Steve Jobs. It will be up to the hedge funds and other activist players to remind them that there's only one Steve. So hand over those dividends.

With Saijel Kishan, Katherine Burton, Jeff Kearns, and Nick Baker

Bloomberg Businessweek Senior Writer Farzad covers Wall Street and international finance.

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