Life Cycles of Companies...Mature Companies (Large Caps)
Four
Non-operating Assets
A
significant chunk
of a firm’s value comes from its non-operating assets (cash, marketable
securities and holdings in other companies). While cash and marketable
securities are by themselves neutral investments, earning a fair rate of
return (a low one, but a fair one given the risk and liquidity of the investments), there are two scenarios where a large cash balance can be value destructive. The first is when cash is invested at below market rates. The second arises if investors are concerned that cash will be misused by management. Returning cash to stockholders in the form of dividends or stock buybacks will make stockholders better off. Then again if the management team has a history of efficiently allocating the companies capital (acquisitions) to enhance shareholder return , the stockholders will again benefit. So once again it depends on who is managing the company and their history of handling the firm's excess capital.
Firms with substantial cross holdings in diverse businesses may find these holdings being undervalued by the market (the conglomerate discount). Spinning off or divesting the cross holdings often exposes their true value benefiting both the parent company and its stockholders.
Spinoffs or divestitures are a particularly interesting subject and I will have more to say about them in a separate blog post.
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