Based on our discussions with CFOs and executives in the technology industry, tax reform has become a major topic for management and boards. Recent analysis by my colleagues David Cogman and Tim Koller shows that technology companies hold about 76% of the cash that could be repatriated (see, The real story behind US companies’ offshore cash reserves). Further, just seven technology companies control about 60% of the distributable cash.
The tax reform debate will have major implications for the tech sector regardless of the outcome. If all goes as anticipated, legislators will reach some agreement on tax reform that encourages companies to repatriate overseas earnings. If legislators can’t reach an agreement, or if they put onerous constraints on how that cash is used, companies will need to consider what to do next. Many have held off repatriating overseas capital in anticipation of reform. But if reform falls through in the current Congress, it could be some time before another reform-minded Congress is seated. Would companies continue accruing capital overseas indefinitely? What kinds of opportunities (or market events) might trigger them to bring cash home regardless of the tax—or double down on their investments overseas? Is there a first-mover advantage to repatriating cash sooner?
Either way, tech companies with significant and growing cash holdings face pressing questions. Based on conversations with CFOs and executives across the tech industry, there are four major challenges that tech leaders are facing, particularly those at companies with significant offshore cash holdings:
- Needs of a new shareholder base: Shareholder turnover is already underway in anticipation of potential repatriation tax reform, with new investors moving into companies with significant off-shore cash balances. A changing investor base means changes in expectations, which CFOs and CEOs need to better understand and anticipate. This could imply different expectations for capital allocation from new investors if reforms were to happen, or a potential headwind for the share price if reforms hit a significant roadblock. This uncertainty makes clear investor communications more important than ever, providing investors with a long-term perspective on the company’s plans for their excess cash reserves – if reform succeeds or fails – combined with outreach to intrinsic investors.
- Putting a cash windfall to work: Tech companies have pursued capital allocation strategies that differ significantly from companies in other industries, partly because a lot of cash was parked offshore. This involves significant investments in growth, less focus on returning cash to shareholders and low debt leverage. Technology company growth, at least among those with overseas cash hordes, doesn’t seem to be typically constrained by capital. So the bigger risk may be that they may invest in things that they shouldn't, if reform were to happen and cash holdings were repatriated. CEOs and CFOs will need to work closely with their boards to understand how to transition their companies to a new reality without this constraint. They will need to reconsider their approach to leverage, share buybacks, dividends, R&D investments, and more, given the amount and readier access to cash. This is a significant shift, and executives expect it will take 1-2 years for boards and management to adapt.
- Pick up in activism: Investor activism may increase, particularly around companies that don’t act quickly once reform is implemented. As my colleagues David Cogman and Tim Koller mention in their recent analysis, most of these companies have few value-creating options for investing more cash other than returning it to shareholders, which is what they did the last time a tax repatriation holiday occurred. Significant cash balances often attract activist attention, particularly if shareholders are expecting repatriated cash to be returned to them. Companies will need to plan their capital allocation strategies well ahead of time, and be ready for activist investors to try to force their hands.
- Potential for large-scale M&A: As companies gain ready access to off-shore cash, large scale M&A may increase. Leaders have an opportunity to consider previously impossible combinations, and they ought to consider who might have their own company on a short list. The profile of transactions may also shift to those relying on cash. However, for very large deals, availability of targets, regulatory risk and the ability to create value are important considerations.
As Washington shifts its focus to tax reform, we believe that now is the time for scenario planning and debate so that tech leaders are ready to act if tax reform comes to pass, in the many shapes it may take.
Sid Tandon is an Associate Partner in our Silicon Valley office.
This blog was previously published on LinkedIn.