2008May Tech Firms Prepare for Slowdown

2008May Tech Firms Prepare for Slowdown

The past six months have been turbulent, to say the least.  We have lived through what, in retrospect, will probably be recorded as the worst credit crunch since the savings and loan crisis of the late 1980s and early 1990s or possibly even the Great Depression.  We saw Bear Stearns, a venerable Wall Street name, fail and be bought out by a competitor with the help of the Federal Reserve.

In this kind of environment, it’s not shocking to see technology firms hoarding cash.  After all, the safest way to fund your business is through “self-financing,” or relying on your own cash savings rather than the whims of the capital markets.  Still, to the casual observer, it would appear that these companies are bracing for Armageddon. 

Tech firms increased the cash on their balance sheets by a full 6% in 2007, compared to 1.5% for all the companies of the S&P 500 as a whole.  The tech sector has a whopping 25% of its assets in cash and equivalents, and household names Apple, Google, and Cisco Systems have cash as a percentage of assets of 61.4%, 56.1%, and 41.0%, respectively*.  Much of this cash stockpile has come at the expense of capital spending, which is sensible during recessionary times.  It makes little sense to expand your manufacturing capacity during a business contraction.

But beyond these cyclical fluctuations, we believe there is a bigger structural shift underway.  Most of the established technologies that have driven productivity growth in the 1990s and 2000s will reach the market saturation point within the coming years, if they have not done so already.  The ubiquitous microprocessor has already made its way into everything from your office computer to your coffee machine.  Likewise, it is truly rare to find a person without a mobile phone today, and marketing efforts now revolve around getting you to upgrade to a newer phone with more gadgets.  Could it be that tech companies are hoarding cash because they see limited room for long-term growth in their key product areas?

The truth is, the tech sector is no longer the sector of romantic young rebels fighting the entrenched business establishment.  The tech firms now are the establishment, even if they like to pretend otherwise.  This means that in the coming years, we expect tech firms to start acting like “normal” companies.  Rather than keep 25% of their balance sheet in cash, we expect these firms to start or increase dividend payments and to buy back their shares in the open market.  In a prolonged slow-growth environment, this is how firms can best produce shareholder value.  We would also expect to see an increase in mergers and acquisitions activity, as firms find it easier to join forces rather than fight in a ruthlessly competitive market. 

* Source: Tam, Pui-Wing. “Tech Firms Cradle Cash,” Wall Street Journal, April 17, 2008