I will try to type this between rain drops.
Although it is not quite earning season, I wanted to comment on the proposed purchase of Ixia by Keysight for $1.6B. Although it was not in response to my posts, in spirit the move was in response to what I was saying. The purchase was made with Cash. That is very unusual by itself. Here I want to talk about why too much cash is a big deal to investors and what the responses are to it.
Companies need cash for day to day operations and paying the bills. They definitely need to have a reserve as well to be able to handle extraordinary expenses. Beyond that, you really want the companies that you invest in to limit the amount of cash that they have. There are reasons that they don’t and it is something to consider while you are investing.
There are 2 values for a company that is important here. First is Market Capitalization and the second is Enterprise Value. Market Capitalization is the total value of the stock of a company. Enterprise Value removes any Net Cash from the Balance Sheet and removes it from the value of the company. Now, I suspect that was not clear and so I will explain. Imagine you were selling a wallet and a guy offers you a dollar. The wallet is worth a dollar. Now, put a $100 bill in the wallet and offer it for sale. The same guy should offer you $101 – $1 for the wallet and $100 to cover the cash. The value of the wallet has not changed. The wallet is like Enterprise Value and the Market Capitalization is like the $101. The stock price is higher, but it is all about cash.
Companies are not generally allowed to directly invest in the large scale unless they are an investment firm. An operating firm is supposed to deploy its cash to make itself more valuable. That means that the ROI on the cash is not high. The main job of a company is to not lose the cash. Because of that, you are not making very good returns on the cash part of the Market Capitalization (right now 1% or less). That is not why you invested and you should be asking the company to give you the cash (if it has too much) so that you can invest it and get a better ROI.
Now if the company does so, it has 3 basic choices. The first is a dividend. This can be one-time or a long term payment of cash to the shareholders. The stock price will decline to compensate, but you will now have the cash to do what you want. The second is a stock buyback. In this case, a company buys its own stock with its cash. This lowers the number of shares outstanding and should drive up the value of the stock. Finally, the company can invest in a new initiative – in Keysight’s case the purchase of Ixia.
We will ultimately judge the investment through the growth of Keysight stock in the future. The company is telling you something by doing the purchase. They are telling you that you will get a better ROI from letting them invest the money in Ixia than you will be able to do somewhere else. You will be the judge of that and we will see how things proceed.
Thanks and have a great day!
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