Hundreds of Billions Sitting on Tech Companies’ Balance Sheets

Thu, Mar 1, 2012 - 2:41pm

Where Will All that Cash Go?

There are two trends in the world of technology that are continually gathering steam and can't help but collide.

Follow the Tech

First is the meteoric growth in the worldwide movement of data, particularly via mobile devices, and how that projects into the very near future. The numbers are way beyond the grasp of the normal human mind.

This is a technology that's barely out of diapers. The first flip phone didn't reach consumers until the Motorola clamshell stormed the scene in 1997. Now the worldwide mobile-phone population is almost 6 billion; by the end of next year, there will be one for every man, woman and child on the planet.

And the first mass market smartphone, Apple's iPhone, has only been with us for five short years. Yet last year, across the globe, sales of smartphones totaled nearly a half-billion, a figure that's expected to double by 2015.

Today, about the last thing someone wants a smartphone for is to hear the sound of another human voice. Customers are demanding ever more from these amazing devices, from texting their pals to watching videos, to trading stocks, to making a dinner reservation, to measuring the distance to the 13th green. And much, much more. Almost anything you can conceive of, yeah, there's an app for that. It's an anachronism to call them phones anymore.

All of which means there's already a staggering amount of data that must be moved, bit by byte, and the industry's growth curve has morphed into a line that is virtually vertical. Talk about incomprehensible. The average person has barely gotten used to hearing the word billion bandied about like it was a commonplace amount, but a billion is so yesterday. How about a billion billions?

Although there's no generally agreed-upon definition for the term cloud-entries range from "virtual servers available over the Internet," to "anything you consume outside the firewall," according to InfoWorld, which ultimately opts for "any subscription-based or pay-per-use service that, in real time over the Internet, extends IT's existing capabilities"-there's no doubting the intensity of the migration of data cloudward.

In its recent publication, Visual Networking Index Global Mobile Data Traffic Forecast for 2011-2016, Cisco predicts that worldwide mobile data traffic will increase 18-fold over the next five years, reaching 10.8 exabytes per month - or an annual run rate of 130 exabytes. For those scoring at home, an exabyte is a billion billions, or one quintillion.

Think of it this way. Suppose you have a computer with a 500 GB hard drive, and it's crammed full. A run rate of 10.8 exabytes means you have to move the entire contents of your drive from somewhere to somewhere else, 21.6 million times. Every month.

And remember, that's just mobile. There is also traffic among traditional, fixed data centers. Not to mention the mass stampede to the "cloud."

According to Cisco, yearly IP traffic over all data center networks, combined, passed the zettabyte mark in 2010 (a zettabyte = one sextillion, or a trillion billion bytes), and the company projects that that number will reach almost 5 zettabytes annually by 2015, with cloud computing comprising about a third of the total. The data equivalent of all movies ever made will then cross Internet networks - every five minutes.

No two ways about it, managing that data stream is one nasty job. It's an extraordinarily complicated job. But somebody's got to do it. And not just one somebody, either; there's far too much data for that. Everyone in the information technology business is scrambling to take as big a slice of this Boston cream pie as they can cut for themselves.

Almost on a daily basis, the big companies roll out enhancements to their services, while any number of smaller outfits nip at their heels, promising to tweak some aspect of the process so that it runs faster, simpler or safer.

That's trend number one. It's huge, it's getting huger, and it's unstoppable.

Then Follow the Money

Trend number two consists of a single word, although as with real estate and location, it doesn't hurt to repeat it thrice: cash, cash, cash. The tech giants are awash in it. They're hauling it in hand over fist. They're making so much money, they literally don't know what to do with it all.

How much cash and cash equivalents are on their balance sheets? Well, based on the holdings of just the 35 members that comprise the Morgan Stanley Technology Index, levels have grown over the past year by 21%, to $513 billion. Over half a trillion dollars. Serious money. Among the biggest holders:

  • Cisco - $44.4 billion
  • Google - $45.4 billion
  • Microsoft - $51.7 billion
  • And of course, the king of the hill would be Apple - a whopping $97.6 billion

One of the reasons there's so much sloshing around in the till is that a large percentage of this money is held overseas. Globalization is a fact of life for everyone, but for many of the largest tech companies it's even more important than that, because they generate the majority of their pre-tax income abroad. And there it still resides. To the tune, all companies included, of some $1.5 trillion. Why? Because overseas tax rates are substantially lower than they are stateside.

The corporate tax rate in the US is 35%, which will be the highest in the developed world after an April Japanese tax cut. By contrast, most large S&P 500 firms pay an international tax rate between 13% and 25%, while many of the tech giants pay 10% or less. Apple, according to an analysis by market watcher Bernstein Research, pays less than 3%.

So if you were them, what would you do? Right. Repatriation of funds for these companies would come at a steep cost that makes no sense to them at this point.

Now, President Obama is offering to cut the domestic rate to 28%, but that's still a lot more than Apple and others are paying. Plus, there are conditions attached that don't sit well with various interest groups. With so much election-year arm-waving going on, and people on all sides pushing their agendas, the chance of any meaningful corporate tax change happening before November is near nil.

There is, however, always the possibility of a tax holiday. This was tried before, in 2004-2006, when US companies took advantage of the opportunity to bring back more than $312 billion over the two-year period. But opinion on what that achieved is deeply divided. Some studies indicate that companies used a substantial portion of the repatriated revenue to increase employment and investment above what they otherwise would have done. But others conclude that the companies mainly used the money to pay off debt, hand out dividends and engage in stock buybacks. The results differ because corporate resources are fungible, and any attempt to tie a particular expenditure to a particular source of funds may depend more on the bias of the investigator than anything else.

Many proposals for different varieties of tax holiday have been floated. None has yet achieved the kind of traction that would suggest a mutually agreeable deal could be struck between Republicans and Democrats. But hey, this is an election year, and both sides will have to attract a fleet of 18-wheelers filled with corporate cash. So you never know, anything could happen.

One thing we do know, though, is that companies can't just let their billions sit there indefinitely, doing nothing. We may see a spike in dividends, as some analysts believe, ahead of tax hikes due to kick in next year. That would benefit shareholders, including corporate officers who have stock. But it won't much benefit the companies going forward. Not when their future success will largely be measured by how much of the aforementioned pie they can grab.

You can't run in place in this business. Nor is simple innovation enough. To maintain your position, or improve it, your innovations have to be better than your competition's. And if you are an established company with funding resources, there are only two ways to do that: develop new product in house, or go out and buy it.

Both will happen.

In-house development, however, is costly, time intensive and totally dependent of having exactly the right kind and quality of brain power already on board. Oftentimes, it's simpler and cheaper to just take over a company that's already done the necessary spadework.

Not all of that valuable intellectual property is for sale, of course. Some will result in IPOs, on the part of companies that want to maintain their independence. And some of it will remain private, supported by investment from venture capital firms.

But the deep-pocket players will play. They have to. It's just sound business practice. With the vast amount of money presently on the sidelines, with fingers itching to pull the trigger on putting it to use, and with low levels of debt throughout the tech field, you can bet that there is going to be an explosion in mergers and acquisitions. Many of them for cash.

In fact, the mania is already approaching a boil. 2011 saw nearly $200 billion in M&A activity, the most since 2007's pre-crash peak of $264.4 billion (albeit well short of the $585 billion all-time record set in the last of the go-go years, 2000). That represented a 36% increase in technology deals last year, far ahead of the 4% advance for all M&A worldwide, according to Bloomberg.

Included were such blockbuster deals as: Hewlett-Packard's agreement to buy Autonomy Corp. for $10.3 billion, as H-P maneuvers to build its software business while scaling back on its PC manufacturing; Google's bid of $12.5 billion for Motorola, which was more about the latter's mobile patents than its hardware; and Microsoft's purchase of Skype for $8.5 billion, the biggest Internet takeover in more than a decade, and a clear effort to gain on Google in online advertising and on Apple in mobile software.

There is also a carryover of some $8 billion in private equity deals that have been announced but didn't close by the end of last year.

Chet Bozdog, global head of technology investment banking at Bank of America, believes that "this year's technology deal volume could be bigger than last year's, and 2007's," and he adds that the key is, "Convergence between hardware, software and services will continue to add products to the same sales chains."

Cisco and IBM in particular are known to be looking at strategic moves that would boost their capacity to provide new storage, analytics and security services to enterprise customers. Apple admitted last month that it's mulling ways to spend its funds and would consider acquisitions. While Google hasn't publicly discussed its plans, it's dead certain to be a factor. And anyone else flush with dollars will be forced to deal or go home.

In fact, Cisco kicked off the buyout season just last week, as it announced that it will pay $271 million in cash plus incentives to absorb privately held networking technology firm Lightwire, Inc. Lightwire brings to Cisco optical connectivity technology, which is the stuff of the next-generation, super-fast networks.

With all of this favoring an M&A mania, there are nevertheless a couple of things that could serve to cool the trend, at least a little.

One is that, despite the recession, valuations in the IT field are sky high. That means companies in the crosshairs will be subjected to very careful scrutiny, to see if the buy price is justified by the amount of value added to the acquirer. It could lead to some measure of trepidation on the part of those controlling the M&A purse strings.

Another is that the IPO waters have been friendlier of late, giving companies a chance to go liquid without giving up control.

Even taking these caveats into account, it's still probably gonna be one heck of a year.

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Editor: Casey's Gold & Resource Report
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