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Once upon a time – call it before 2022 – there weren’t many incentives for companies to hold on to cash. It didn’t earn anything, investors didn’t like management teams to let dry powder just sit there, generating a negative real return. Of course, cash is never a bad sign. But the point of equity investing is to get exposure to something a little bit more dynamic, improving the return on assets in the process.
If anything, investors preferred executives to extend and optimise their use of leverage. With the cost of capital so cheap, it made sense for most corporates to borrow, and put both cash and debt financing to use in pursuit of higher returns on equity. By contrast, there was little prestige in a big piggy bank.
Today, with cash earning 5 per cent at no risk (and risks everywhere) this logic has changed. For one, it raises the likelihood that investors will sit on cash themselves. Many now do, which is one explanation for many asset managers’ struggles to keep hold of client funds, and broader efforts to raise fresh equity. But for those taking an active approach to stockpicking, and thinking about valuation, potential takeovers and competitive advantages, greater weight now needs to be applied to cash holdings.
Take housebuilder Taylor Wimpey (TW.). At £1.09 a share, its market capitalisation is £3.93bn on a fully diluted basis – or a 14 per cent discount to book value. At the start of July, its net cash stood at £655mn, meaning about one-sixth of every share amounts to a cash buffer yielding around 5 per cent in interest income, at almost no risk.
Seen from the perspective of a potential acquirer – which could cheaply buy the cash assets with cash or a short-term loan – Taylor Wimpey’s enterprise value now stands at £3.2bn. Though the largest in its sector, that’s just seven times this year’s (very subdued) operating profit estimates – and a decent price for a balance sheet that includes a £3.4bn land bank and £1.9bn of investments in projects yet to complete.
From another angle, that cash might be used as a war chest to boost the land holdings or acquire even cheaper competitors. It’s also a margin of safety that should buy the company time until credit conditions eventually improve for homebuyers. In turn, this could make the cash pile a strategic asset.
Currently, however, it’s unclear whether investors are always valuing cash as cash. Take trading platform Plus500 (PLUS), which last week told investors its net cash had risen to $875mn (£721mn) at the end of September. Subtract this from the group’s current market cap, and you’re left with an enterprise value of £420mn, less than two times this year’s consensus forecast for operating profit.
In the case of Plus500, a high cash balance is inseparable from its operations. It is currently building a clearing operation in the US, needs some cash to hedge customer exposure, and must meet net tangible asset and capital adequacy standards across its core markets, which include the UK, Europe and Australia. But its cash holdings also mean it is on course to generate around $50mn in interest income in 2023.
Investors seem to have either not noticed this or assigned an extraordinary level of risk to the business.
To understand why, we only need look back to the third quarter of 2019, shortly after a big regulatory re-set shook up the rules governing its customers’ trading and hit investor sentiment. But despite being subject to similar capital constraints and risk factors, Plus500 was valued at about £900mn, against a $298mn cash balance earning next to no interest.
It may be that investors have assigned a very low value to the group’s historically volatile earnings. But it’s harder to understand why the market apparently sees so little value in its cash pile. So long as these two elements fail to add up, the business looks staggeringly cheap.
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