November 21, 2011
Article from Seeking Alpha
The investment firm Pimco coined the term "the new normal" to describe the post-2008 world. A more appropriate description might be, "the era of perpetual uncertainty." Perhaps the uncertainty was always there, and nowadays people are simply recognizing it more often. But the public is constantly being bombarded with things to worry about. Beyond one's own financial, family, and work obligations, it seems as if we have to constantly worry about whether the financial system itself will collapse, destroying with it the very fabric of our debt-fueled society. If we don't increase the U.S. debt ceiling, we're told the financial system will collapse. If Greece, Italy, or Spain defaults on its debt, we're told there will be an economic calamity. If tax rates go up, we're told it will ruin the economy. If tax rates don't go up, we're still told it will ruin the economy.
Are you a CEO thinking about hiring new employees? How do you create a reasonable estimate as to your future profits in an environment in which so many people feel miserable about their financial situation, and health care costs seem to rise at unpredictable rates? The list could go on and on. And if it did, perhaps the most recent addition to it would be the repercussions of the recently bankrupt broker-dealer MF Global (MFGLQ.PK) allegedly stealing money from its clients.
After the market closed on Friday afternoon, CNBC published the story "The MF Global Money Is Probably Gone: Source." In that story, CNBC reported that, "In the futures business, MF Global was allowed to use 'idle' cash in customer accounts to make investments on its own behalf." The story went on to report that MF Global would "borrow" from its customers' accounts and post collateral. However, the article goes on to say that at some point in October, the firm allegedly stopped posting collateral. In other words, the firm took the money out of its customers' accounts and used the money however it wished.
It's been said that desperate times call for desperate measures. Whether the allegations against MF Global prove to be correct or not, the story itself got me thinking about the safety of my "idle" cash and what "cash" really means. As a result, I decided to look at what analysts and fund managers call "cash" on the balance sheets of various public companies. This is the cash that supposedly will someday be put to work and save the economy. It's one of the reasons often cited for why investors should feel comfortable buying the equity of various companies. Is it really cash as the public would think of cash? Or is it actually money invested in financial instruments that society has become accustomed to thinking will always be accessible? That corporate "cash" is certainly not sitting in the form of dollar bills in a giant safe box at company headquarters. I wish the data were more updated, but the Federal Reserve Bank of New York's website currently states that as of December 2007, there was roughly $829 billion of U.S. currency in circulation, and that most of it is held outside of the United States. On the other hand, Apple (AAPL) itself is said to have over $80 billion of "cash" on its balance sheet.
Does one company, Apple, really have locked up the equivalent of almost 10% of all the U.S. currency in circulation? The answer is no. While Apple's "cash" hoard is impressive, it's important to understand that this money is invested in various securities. According to its latest 10-K, as of September 24, 2011, Apple had "cash and cash equivalents" of $9.815 billion, "short-term marketable securities" of $16.137 billion, and "long-term marketable securities" of $55.618 billion, for a grand total of more than $81 billion. As you dig into where this money is invested, you discover that as of September 24, Apple had $10.717 billion in U.S. Treasury securities, of which $7.354 billion was listed as "long-term marketable securities." The "long-term marketable securities" category also has, among other things, $11.445 billion in U.S. agency securities, $28.008 billion in corporate securities, and $3.469 billion in "Non-U.S. government securities."
Apple's 10-K defines "long-term marketable securities" as "debt securities with maturities greater than 12 months." So the next time the debt ceiling debate heads to the final hour and the possibility of a U.S. government default looms overhead, how should this "cash," and therefore Apple's stock, be valued? The next time we head into a serious recession and corporate bid/ask spreads widen, how should investors value the "fair value" of those corporate securities Apple holds, and how would that affect its stock price?
Apple is one of the most successful and innovative companies in the world. Its stock is a favorite of analysts and fund managers. The company's products are adored by people worldwide. If this company is putting its money in Treasuries and foreign government securities, among other things, many other companies are likely doing so as well. Is this "cash" really safe? Think about the types of banks world-wide that are handling the cash of stock market darlings like Apple and Google (GOOG), or other companies like Microsoft (MSFT), International Business Machines (IBM), and Intel (INTC).
Google's latest 10-Q reports cash and cash equivalents of $10.63 billion as of September 30, 2011, as well as $31.93 billion in marketable securities. When looking at Google's $31.93 billion of marketable securities, you discover $7.062 billion of it is invested in "Agency residential mortgage-backed securities." Yes, you read that correctly: Agency RMBS! Google also has $7.298 billion is in corporate debt securities, $6.860 billion is in U.S. government agencies, and $5.961 billion is in U.S. government notes (notice the word "notes," not bills). The next time you hear people mention that Google has over $40 billion in cash, ask them their opinion on agency RMBS.
Microsoft's latest 10-Q showed cash and cash equivalents and short-term investments of $57.403 billion as of September 30, 2011. MSFT's 10-Q breaks down "the components of investments" into various categories, including "U.S. government and agency securities." This category showed a cost basis of $35.953 billion. "Corporate notes and bonds" showed a cost basis of $12.788 billion, and "Common and preferred stock" had a reported cost basis of $7.348 billion. Again, yes, you read that correctly: Stocks! The next time someone quotes you a Microsoft "cash" number anywhere above the $12.881 billion it reports in "cash and cash equivalents," ask that person why they consider "common and preferred stock" to be cash.
IBM's latest 10-Q reported cash and cash equivalents of $11.303 billion as of September 30, 2011, some of which is invested in U.S. government securities and commercial paper. Finally, Intel's latest 10-Q showed $10.933 billion in cash and cash equivalents and short-term investments as of October 1, 2011. This was invested in, among other things, government bonds, corporate bonds, and commercial paper.
We currently live in a world in which the financial system is so interconnected that sovereign issues in Europe could severely affect European banks, which could then severely affect U.S. banks. Do you know which bank(s) holds the "cash" of your favorite company? As "cash" hoards grow ever larger at U.S. financial corporations, how should they be valued whenever global systemically important financial institutions (SIFI) look to be in trouble? In a post-MF Global world, a world in which we seem to bump up against the U.S. debt ceiling every couple years, and a world in which the health of sovereign nations and SIFI banks seems to be constantly questioned, these are all questions that should be thought through when trying to determine how to value "cash."
In an era of perpetual uncertainty, a time when a major brokerage house apparently had the wherewithal to do something so nefarious as steal its clients' cash, I start to wonder what exactly cash is, how it should be defined, and how it should be valued in an investment portfolio and on a balance sheet. During this Thanksgiving week, one of the many things I am thankful for is that I wasn't a client of MF Global.