Cash-Stuffed, Stingy, and Scared


By Steve Rosenbush Several years ago, business spending in the U.S. slammed to a neck-wrenching halt. After loading up on equipment and personnel during the stock market fueled boom of the late '90s, managers across the U.S. woke up in early 2000 and realized their companies were deep in debt and that revenues were nowhere near what the optimists had predicted. So began three years of layoffs, bankruptcies, and cost-cutting. When it came to capital budgets, the only questions were how far and how fast to cut.

The brutal corporate cleanup succeeded in its own terrible way. While it wiped out a half-million jobs and $2 trillion of value in the capital markets in telecom alone, corporate ledgers were purified by fire. By some measures, balance sheets are cleaner than they've been in nearly 50 years. Thanks to cost-cutting and the low rates of interest and taxes that were necessary to reenergize the economy, corporate profits are back on track.

FINANCING GAP. Businesses are literally earning more money than they're investing. Companies have so much cash, they have little use for banks. They're like well-heeled homeowners who can build a house with their own funds, skipping the mortgage.

Consider: After the third quarter of 2000, businesses invested $337 billion more than they needed to spend on factory expansion and so forth, making up the difference by borrowing. But at the end of the first quarter of 2004, internally generated corporate cash flow exceeded business investment by nearly $63 billion.

The reversal of this so-called financing gap is rare, according to Mark Zandi, chief economist of researcher Economy.com. "Balance sheets are in good shape, and companies are well positioned to expand and grow," Zandi says.

OVERLOOKED PILLAR. Sure, business investment and capital spending have picked up over the last year, but they're nowhere near their potential. And CEOs aren't doing much to boost the labor market, which added an anemic 32,000 jobs in April. Unlike a few years ago, companies have the resources to spend more if they were so inclined.

So, why aren't they spending? The spike in oil prices and conflicting economic data, not to mention uncertainty surrounding war, terror, and the 2004 election, leave them hesitant.

All that cash is an overlooked pillar of strength for the economy. And sooner or later, companies will put it to work. "It has to go somewhere," says Zandi. "Right now, it's sitting in bank accounts and finding its way into real estate markets. But eventually, that liquidity should engender more economic activity."

DIVIDENDS AND BUYBACKS. Executives just don't seem to know what to do with the money. Microsoft (MSFT) alone has $56 billion in cash, much of which it's returning to shareholders in the form of dividends and stock buybacks. Software giant Oracle (ORCL) has about $12 billion in cash and short-term securities, which it's using to acquire other companies. Computer giant Sun Microsystems (SUNW) has $8 billion in cash, which seems destined for acquisitions.

Even struggling telecom MCI (MCIP), which recently emerged from bankruptcy entered into as WorldCom, is returning $2.2 billion in cash to its shareholders. Apparently it can't find a better investment to make.

Dividends and stock buybacks are great for investors in the short term, but don't necessarily lead to investment in plants and new equipment, let alone job creation. And mergers may help boost efficiency and corporate profits, but they're viewed as an opportunity to reduce capital spending, not boost it.

"IT'S GOT TO." Sooner or later, companies will reach the end of this unimaginative spending pattern. Just as the period of cost cuts came to an end, so will the era of buybacks and dividends. Pressed to generate more revenue, companies will begin to use their money to take risks and make investments.

In the telecom sector, Verizon (VZ) is using its $13 billion capital budget, one of the largest in the world, to build a next-generation phone system that can carry video as well as voice and high-speed data. CEO Ivan G. Seidenberg summed it up nicely in an interview in 2003 when he said: "The simple fact is that all the money that has been pumped into the market...has got to come out the other end some time. It's got to."

When that happens, it will change the way the economy is perceived. The political implications could be huge, too. If spending picks up quickly, it could help President Bush's reelection effort. But if it doesn't happen until after November, it could help John Kerry win the White House. And just as Bush inherited an economy wrought with a stock market crash and a recession, Kerry could inherit one that is poised to grow.

It's like damp timber, Zandi says. Sooner or later, the weather is going to clear and the wood is going to dry. And then that cash will be able to generate some real heat. Rosenbush is a senior writer for BusinessWeek Online in New York


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