Corporations as the new banks?

20 May, 2009 | by


Forbes magazine had an interesting piece about large business acting as lenders to small business. This comes right behind the biggest credit meltdown in history. This lending comes in the form of retail financing or vendor financing, and in some cases, in the form of corporate venture funding. In 2008, as per NVCA, corporate venture funding arms amounted to 19.2% of all venture deals, an amount that works out to $5.4B out of total deals worth $28B. Similarly, the Forbes article pointed to $52B raised for corporate non-venture financing.

What does this mean for the shareholders in these corporations? Let us look at a few numbers. A stock screen on Yahoo for companies with positive free cash flow, and picked companies that have positive cash balance on their balance sheets reveals about 896 stocks, and most notable among them being Berkshire Hathaway with $16440 of cash available per share. Since free cash flow does not include the cost of debt servicing by these companies, one should also look at the total debt assumed by these companies. A vast majority of these companies have very little to zero debt on their balance sheets. So, to keep matters simple, let us assume there is no debt servicing expense.

The stock screen reveals that, on an average, after excluding outliers such as BRK-A, each company has a 15% return on equity, and $1.3B of cash in the bank. There is a total cash position of $1.2 trillion. In other words, the $5.4B invested by the corporate world is a drop in the bucket. In an earlier post, I had touched upon the reasons for decreased semiconductor venture funding. The current economic conditions preceded by prior bust cycles make corporations cautious and hoard cash. But …

Imagine the possibilities:

  1. If average ROE is 15%, the corporation could reinvest the cash in its core business and get a 15% return. This is possible only if there are opportunities in the current line of business.
  2. Another avenue for the use of this cash is investing in upcoming ventures. Most new ventures are funded on small slivers of capital. Therefore, this may not be a workable option.
  3. Given that corporate AAA/BAA bonds are currently yielding 8%, lending to other businesses is the next best alternative.
  4. Another possibility is vendor financing for small businesses and new ventures. Instead of using the cash to take an equity position in these businesses, the corporations would offer products and services with financing terms comparable to the BAA bond yields.
  5. Finally, the capital can be returned to shareholders, thus boosting the shareholder returns.

It seems that the possibilities of vendor financing and dividend payouts are possibly the best alternatives in the current bleak economic scenarios. Will corporations be the bankers of the new finance era? What will tilt the balance of power? Stay tuned.

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