Canadian companies are so flush with cash that unless they start putting it to good use, they risk becoming prime targets for foreign takeovers, a new study concludes.
Corporate profits are at their highest levels in decades across North America, and companies have been sitting on their cash -- to their own detriment, the study by Royal Bank of Canada says.
In Canada, companies should start pouring some of that cash into enhancing productivity or boosting capacity, or they risk being bought by a foreign company on the lookout for cash-rich assets, author Derek Holt said.
"If we don't find more profitable domestic uses for that liquidity, and become more efficient in our companies, invest more and spend more on research and development, then we're making ourselves more and more susceptible to foreigners coming in and taking the cash out of our companies," Mr. Holt said in an interview yesterday.
In theory, he said, companies with extra cash would also be in a good position to buy other companies.
But since Canada is generally dominated by smaller companies -- at least by global standards -- they risk being targets rather than the aggressors in a mergers-and-acquisition boom.
"They're playing it far too conservative in how they're managing their corporate finances," Mr. Holt said.
It's not just oil and gas companies, he added. In 28 out of 30 corporate sectors tracked by his bank, "they have more internally generated cash than they know what to do with."
The pace of mergers and acquisitions activity has been hectic, and Canadian companies are the targets more often than not. Last year, foreigners bought $66.4-billion worth of Canadian companies, while Canadians spent less than half that amount on foreign companies. The average purchase size of foreigners buying in Canada was about $500-million, while the average deal size for Canadians buying abroad was $100-million.
Despite their high profits, Canadian companies are facing an onslaught of challenges: the high Canadian dollar, stiff competition from Asia, rising energy prices. But they're not spending their extra cash on becoming more competitive, Mr. Holt noted.
The manufacturing sector has made notable gains in productivity in the past couple of years, he conceded, but the investment in new machinery and equipment hardly makes up for 25 years of underinvestment, he said.
The corporate profit picture means credit ratings are high, and loans are readily available. But since there's no shortage of liquidity these days, Bay Street should focus more of its resources on mergers and acquisitions rather than underwriting, Mr. Holt added.
Canadian banks may be looking for opportunities to spin a dollar out of this flood of cash, but they're hardly immune to the problem. The country's largest banks are accumulating capital at a furious pace, but are having a hard time spending it. The Big Six have just under $10-billion in what they call "excess common equity," while the three major insurers have about $6-billion in extra cash.
"I think excess capital is arguably the most important broad-based theme that's facing the financial services sector right now," said Robert Wessel, an analyst with National Bank Financial Inc.
Manulife Financial Corp. chief executive officer Dominic D'Alessandro joked with analysts last week that the company's high capital levels were "a terrible problem to have." Manulife distributed about $2.2-billion to shareholders last year through dividends and share buybacks, but the company still has more than $3-billion of excess capital.
But many companies have very good reasons to sit on their money, said Clément Gignac, chief economist at National Bank Financial. Some are investing offshore and their transactions don't show up in national data; others are spreading out their profits through income trusts. And some don't buy into Bay Street's bullish view on oil and gas prices, and don't want to be caught short in a downturn, he said.
And not every sector is ripe for takeovers, Mr. Gignac said. Some manufacturers may find it very difficult to attract buyer interest.
© The Globe and Mail
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