Debt-shy Asian companies are like cash machines

SINGAPORE: The world’s richest Indian recently lost an opportunity to get even richer. Lakshmi Mittal, who was in the race for Mitsui & Co’s controlling stake in Indian exporter Sesa Goa, was beaten by compatriot Anil Agarwal. Agarwal’s Vedanta Resources picked up Mitsui’s shares and announced a plan to buy a further 20% from the public. The total cost is $1.37 billion, most of it funded by a loan.

Sesa Goa is an iron-ore mining company. Arcelor Mittal’s steel plants could have used that stuff. Vedanta produces non-ferrous metals. Analysts speculated that Agarwal probably wanted to lower his commercial risk by adding iron ore to the copper and zinc businesses he already owns.

That’s probably true. Yet, Sesa Goa’s real appeal isn’t in the company’s mining projects, but in its financial statements. It’s virtually an automated teller machine. Take a crude measure of the company’s surplus cash flow: the money it made from mining last year minus what it invested. Divide that by long-term borrowings. You get a figure of, hold your breath, 885. Only one company in the Standard & Poor’s 500 Index — McGraw-Hill Cos — is more tempting, if you exclude those that have no debt and need to be judged by other investing yardsticks.

Buyout firms, on the prowl for under-leveraged companies, love targets that can service loans costing 150 basis points above the London Interbank Offer Rate with their own cash flows. Company boards in Asia should pay attention to cash. Buyout funds are bound to come calling soon, if they haven’t already. If control is important, manager-owners should follow the lead of Malaysian billionaire T Ananda Krishnan, who is buying out minority shareholders in Maxis Communications, the country’s biggest mobile-phone operator, possibly by raising funds in the bond market.

Among companies in Asia, excluding Japan, with at least $1 billion in market value and some long-term debt, Sesa Goa’s “LBO attractiveness” is only exceeded by Taiwan’s Inventec, one of the world’s top manufacturers of notebook PCs, and Bursa Malaysia, operator of the country’s stock exchange.

Loans raised for Asian buyouts surged to $28 billion in 2006, from just $7.5 billion in the previous year. Almost 45% of the activity, however, was concentrated in Australia. The base may now broaden. From a Taiwanese maker of golf-club heads to an Egyptian fertiliser company, all kinds of emerging-market assets are now in play. Within Asia, Taiwan has an added advantage. Not only are its technology companies generating dollops of cash, stock-market valuations are cheap. The price-to-earnings ratio of Taiwanese stocks is about 19 now, compared to a 10-year average of 29.

Getting acquired is, of course, one of several options. The other is to go out and invest in new assets or return the excess cash to investors. JT Wang, chairman of Taipei-based personal-computer maker Acer, said in April that he would do both. The companies that follow Sesa Goa closely on my “Asian ATM” list are PT Tambang Batubara Bukit Asam, a state-run Indonesian coalminer; and KT&G Corp, South Korea’s biggest tobacco company. Both are under-leveraged: They can pay their long-term debt with the free cash they generate in half a day. Bukit Asam said last month it would use its growing pile of cash — and take loans — to acquire rivals.

KT&G ended up on investor Carl Icahn’s radar last year. Together with US hedge-fund manager Warren Lichtenstein, Icahn bought stock in the company and threatened a takeover unless shareholders got a better deal. Icahn and Lichtenstein ended their alliance after KT&G announced plans to buy back shares and pay higher dividends.

The strategy of Asian managements in the past few years has been to make the best possible use of existing assets. They have made the wheels of business turn faster. In many instances, that strategy fetched ample returns for investors. But it hasn’t always worked. Hindustan Lever, the Indian consumer-products company controlled by Unilever, has sold at least half a dozen businesses in the past five years and yet managed to boost both sales and return on equity even with pre-tax margins that are narrower than in 2002.

Cash is coming in by the truckload, and the company is returning more of it to shareholders than it is investing in its future. The markets are unimpressed. Shares of Hindustan Lever have given a total return of 30% over the past five years even as the benchmark Sensitive Index has returned 410%.
In December, Patrick Cescau, the Unilever chief executive officer, said the Indian unit would seek new acquisitions in India. Investors are waiting. Why are companies in the developing economies of Asia not investing more boldly? “This reluctance to invest may reflect some lingering cautiousness stemming from the excess capacity and overzealous investment of the late 1990s and the high hurdle rates used by companies in assessing new investments,” the International Monetary Fund noted in its latest Global Financial Stability Report.

With strong global economic growth and easy financing conditions, the corporate under-confidence is puzzling. It’s time Asian managements stopped gloating over their earnings graph and paid closer attention to cash. Too much of it can be as bad for shareholders as too little.