How a company talks about cash can quickly become a touchy topic
‘Cash is king.’ As every IRO knows, that catchphrase rises to the top of investor thinking when a company hits a rough patch, when rapid changes shift the competitive landscape or when the economy catches a cold.
Cash flow statements and balance sheets can get as much scrutiny as income statements through a lens focused not on upside surprise but on downside risk. As a result, how a company talks about cash flow items quickly becomes a touchy topic, depending on the context. And IROs have to assess whether and how to link that discussion to business results and outlook.
The recent experience of Intel neatly illustrates the point. The world’s largest semiconductor maker – with $53 bn in annual revenue – maintains leadership in a fiercely competitive and capital-intensive industry through aggressive capital investments.
When Intel announced in January 2012 it was boosting capital spending by about 10 percent, or $1.5 bn, for the coming year after predictions of capex cuts, the stock got a nice bump – a vote of confidence for Intel pressing its technology advantage.
Fast forward to January this year, when Intel said it would boost capital spending for 2013 by $2 bn to invest in new technologies several years from now, and investors bolted, nervous that the maturing PC market is losing ground to tablets and smartphones.
It’s a dilemma every IRO has experienced: short-term focus versus long-term strategy. Intel spokesperson Laura Anderson says the company communicates ‘a general philosophy and guiding principles’ around use of cash but does not explicitly tie those forecasts to the business outlook.
Another semiconductor manufacturer, Advanced Micro Devices (AMD), is also closely watched for cash flow, but for different reasons. With substantial leverage, the firm has a large number of debt holders that bring a ‘maniacal focus’ to the company’s balance sheet, according to Ruth Cotter, AMD’s head of IR.
AMD recorded losses and negative free cash flow for 2012, but the firm has consistently provided a range of the ‘optimal cash balance’ it is comfortable with, an important marker for debt holders. In one particular quarter, however, it failed to provide a gross margin outlook, which raised debt holders’ concerns, ‘creating a whole hoopla,’ Cotter says.
The experience highlights the importance of knowing your investor base, she adds, noting that IROs need to look at guidance that affects both the income statement and the balance sheet, depending on a company’s circumstances.
For the past couple of years, questions on use of cash have been ‘one of the top three questions we get,’ says Steve Cantor, IRO at semiconductor equipment supplier Entegris. Not capital-intensive itself, the company lives by the capex of the major semiconductor players. It hit a rough patch with debt covenants during the depth of the recession, but investors’ cash focus today is driven by concerns about the weak macro environment, Cantor says.
Given its significant cash flow, Entegris explicitly lays out cash priorities: buying back shares to stay ahead of option dilution and making ‘both strategic and opportunistic’ acquisitions. But it does not tie those statements to its business outlook, Cantor adds.
Changes in a company’s business operations that affect cash flow can also raise investor concerns if not adequately explained. Hulus Alpay, IRO at medical software company Medidata Solutions and chairman of NIRI, points out that his company’s free cash flow is heavily influenced by software contract payment terms.
Before the firm went public in 2009, long-term contracts had large upfront payments. Post-IPO, with a stronger balance sheet, contracts had smaller upfront payments and longer duration of cash flow.
As a result, ‘cash flow and deferred revenue comparison became more difficult to understand’ without a deep dive into contract payment terms, Alpay says. The lesson for IROs is that, when cash is king, you need to listen carefully to your audience to understand exactly what it means by that.
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Jeffrey Corbin serves as CEO of KCSA Strategic Communications, one of the leading independent investor relations consulting firms in the US. He is also co-founder of theIRApp.com. He has lectured internationally on the topic of enhancing valuation through proper communications and building relationships with Wall Street, and outlines these ideas in his book, Investor relations: the art of communicating value.
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