3 Thoughts on Today's NYT Business Section

These could be three epic-length posts by yours truly, but given my lack of time and your lack of interest I have decided to consolidate my thoughts into this one post on three interesting pieces in today's NYT Business Section.

1. Randall Stross in Digital Domain on VC in the Silicon Valley

First things first. I live in New York. I run a venture-backed company. Before I ran a venture-backed company I knew lots of NY-based VCs and many successful Tri-state area start-ups. Yet somehow, the Silicon Valley PR machine just keeps on cranking out favorable pieces in the popular press. Don't get me wrong; I love the Valley. Super smart people. Super forward-thinking investors. Incredible sources of intellectual capital. Amazing linkages among the entrepreneurial community, the VC community and the university R&D community. They've been at it a long time and really have a finely-tuned machine for incubating and developing ideas. They rock.

But Randall and friends, I've got something to tell you. New York is a great place to do a start-up. Why do I seldom hear more textured analysis about the kind of start-ups that might be better suited to the Valley versus NYC? Say, more consumer-oriented, enterprise-software-type start-ups out West and more B2B, advertising and media-related start-ups out East? The Valley may have all those legendary VCs, a base of successful entrepreneurs, world-class angels and Stanford, but NYC has some pretty awesome VCs, a smaller but growing base of successful entrepreneurs, very well-formed and effective angel groups, Columbia, NYU (MIT not too far away), Wall Street, Big Media, Big Advertising, and pretty much Big Everything Else.  Somehow this all gets lost in the wash - why this is I don't know.

So my message is short and sweet. For all those looking to start a company, please, go to the Valley. That will just leave more for us out here. NYC simply rocks. But it's PR really sucks.

2. Mark Hulbert on the Meaning of Large Corporate Cash Balances

I apologize in advance for taking such large snippets of this article and re-posting it below, but Mark Hulbert has hit on a very important topic that was at the core of some work I did with a colleague in the late 1990s. Here are key extracts from Hulbert's piece and I'll tell you why I believe they are so meaningful below.

PUBLICLY traded American companies hold so much cash that, as a group, they could pay off all their debt and still have money left over. According to a new study, this cash-heavy status reflects a major shift over the last two decades, and it isn’t necessarily a good sign for stocks.

The study has been circulating since September as a National Bureau of Economic Research working paper. It is titled “Why Do U.S. Firms Hold So Much More Cash Than They Used To?,” and its authors are Thomas W. Bates and Kathleen M. Kahle, finance professors at the University of Arizona, and René M. Stulz, a professor of banking and monetary economics at Ohio State. A version is at nber.org/papers/w12534.

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So what is the main cause of the climb in corporate cash? Upon analyzing a dozen factors that economic theory suggests could play a role, the professors found that the biggest was an increase in risk — as evidenced by factors like unpredictable cash flow. Corporations have become less able to count on steady cash flow from year to year, according to the professors, and despite the growth of a complex derivatives market, companies can’t adequately hedge this risk without holding more cash.

This helps to explain why so few companies are paying out their bigger cash hoards as dividends. Because companies are loath to cut or eliminate a dividend once they start paying it, they won’t establish or increase a dividend unless they are highly confident that they can stick with it through thick and thin. But that confidence is precisely what is missing at a growing number of companies.

The professors’ analysis casts an entirely new light on valuation measures that rely on cash levels — gauges like cash-to-assets or cash-to-sales ratios. An investor who relies on such measures often assumes that companies with more cash are less risky, because they have more of a buffer against rainy days.

But this assumption may well be wrong, Professor Stulz asserted in an interview, if the companies holding more cash have more rainy days than companies holding less cash.

To properly compare two companies on the basis of cash holdings, Professor Stulz says, you should first compare their risk, as measured by factors like the volatility of their cash flows. Only if a company is holding more cash than is justified by its risk can we conclude that it is genuinely more conservative.

Professor Stulz says he is not aware of any investment firms that now conduct the econometric calculations needed to make these assessments. And he concedes that those calculations would be complex. But without them, contrasts of companies’ cash levels amount to little more than comparisons of apples and oranges.

This analysis and their reasoning for why corporate cash balances have risen is absolutely spot-on. In the 1999-2000 period, when I ran a team in equity derivatives at Deutsche Bank, I worked with a fellow named Tim Opler (now of CSFB) on a framework for analyzing the "cost of financial distress" for a given company and, therefore, the optimal amount of cash to be held as a hedge. Tim, a former finance professor at Ohio State and SMU and a total brainiac, worked in the Liability Strategies Group at Deutsche and shared my passion for helping companies address this thorny issue. 

We essentially ran models that looked at precisely the things mentioned in the study above - namely, the volatility of a company's cash flows, its relationship to economic cycles, potential changes in business mix and its impact on the characteristics of future cash flows, quantifying what constituted "financial distress" and arriving at a recommendation for a base level of cash or near-cash that should be held to cover this risk. We specifically looked at companies that generated large amounts of cash - technology companies, telecommunications companies, regulated utilities, etc. - and advised managements on corporate finance policies like stock buybacks, dividends, and long-term debt issuance strategies. I will tell you that this type of analytical framework resonated with Treasurers and CFOs alike, and had a real impact on how many companies managed their cash - in some cases, gaining the comfort to increase their dividends/share buyback programs, while others chose to issue long-term debt to build the necessary cushion to most efficiently take the tail risk of financial distress off the table.

In any event, thanks to Mark for raising this issue and citing this study. It will become a core piece of corporate finance literature that should have a material impact on company policy now and in the future.

3. Alex Tarquinio on Bank of America's Retail Brokerage Strategy

Alex writes a nice piece on the nuts and bolts of B of A's new offer. But one story line I seemed to have missed (and, quite honestly, the story line that I want to read about) is how this was a massively disruptive move to the online brokers and how billions in market cap disappeared overnight in the wake of B of A's prescient move. TD Ameritrade, E*TRADE, Charles Schwab - not fun to be them right about now. B of A has, overnight, changed the playing field.

They are a multi-product retail powerhouse. They could, should they so choose, scoop up on of the major online brokers to gain access to retail accounts that they could cross-sell mortgages, credit cards, and a panoply of bank-related products with attractive profit margins. Or, they could pursue an organic growth strategy that just chips away at the big online brokers' client base. B of A did this in the corporate credit market, then derivatives, then debt and equity issuance, then advisory services. Don't get me wrong - Goldman Sachs they are not. But they've got pockets of product excellence, strong management, a deep bench and an unparalleled balance sheet. It will be fascinating to see how this retail brokerage strategy plays out but of one thing you can be sure - they are not messing around. And with a strong stock, 250 billion in market cap and the staying power for a marathon, the world is their oyster.

Thanks, NYT, for raising so many interesting topics this Sunday. I'm looking forward to next week's performance.

Comments

[Roger]

Tyler, may the force be with you on the start-up front. I am confident you will be pleased by the NY start-up ecosystem. Also nice to see another Trevian taking a crack at it! Best, Roger

[Tyler Fonda]

Yes, I think that NY is much maligned for start-ups. However, I am starting one now, so time will tell if CA would have been better. Just seems like there is a lot of great thinkers and entrepreneurs in NYC, hiring up has been relatively easy. As an aside, I also graduated from New Trier.