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Meeting Summary

The 2018 Post-Tax Reform Balancing Act: Put Cash to Work and Fend Off Activists

June 26, 2018
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Mega-cap treasurers talk capital allocation, pension contributions and activist investors, and dig into a tax "spaghetti bowl" that will take time to digest. 

tMega 2018 

US tax reform wasn’t the only topic on the minds of the tMega treasurers meeting at Google’s New York offices in mid-March. But the implications of the law took center stage as members discussed capital allocation decisions, repatriation of overseas cash, credit ratings, pension fund contributions and how to keep activist investors at bay. Other subjects included preventing lapses in cybersecurity, blockchain use cases and BlackRock Chairman and CEO Larry Fink’s thoughts on the markets and long-termism. Here are the some of the key points that emerged:

1) Tax Reform Reality: Opportunity, Risk, Uncertainty. Lower tax rates and the ability to tap into repatriated cash are clear benefits of the law. Decisions on how to deploy excess cash carry potential consequences and risks involving credit ratings and the actions of shareholder activists. The complexity of the new tax regime and how it interacts with preexisting international tax rules leave some questions awaiting regulatory clarification, limiting the ability of treasury to make precise plans quickly.

2) Plotting Pension Moves. The reduction in the corporate tax rate to 21% from 35% prompted many MNCs with tax-qualified defined benefit plans to accelerate contributions to take advantage of the larger tax deduction. This trend will likely continue as companies on calendar years have until Sept. 15, 2018, to make contributions that apply to the 2017 tax year; most of those with off-calendar fiscal years have more time.

Treasury Moves

NeuGroup Peer Research Cash Comes Home

Tax Reform Reality: Opportunity, Risk, Uncertainty

“Cash will not stay on the balance sheet,” one tMega member declared, describing her company’s approach to deploying the increased cash flowing to treasury post-tax reform. The issue looming large for many like-minded treasurers is where that cash will go and when. In the pre-meeting survey, members ranked paying down debt and M&A as the primary expected uses of proceeds from repatriation flows, with 50% indicating they would use the proceeds for either of the two. Share repurchases and other uses (including funding operations and charitable contributions) were next at 45%. Dividends and capex were much lower at 25%. But coming between expected uses and actual uses are issues that treasury and tax at MNCs need to consider carefully.

Long-term Purpose, Transparent Strategy

KEY TAKEAWAYS

1) Communication, yes. Goldilocks, no. “I don’t have any money—thank God for tax reform!” said a treasurer whose company detailed plans to increase capital expenditures significantly in the wake of tax reform. “We’ve underinvested in our networks for years,” explained this member. A banker on Goldman Sachs’ activism defense team said communicating specifics about how companies plan to spend excess cash is key to determining how much time activist shareholders may wait before agitating for change. While companies may want to preserve “optionality” in deciding how to allocate capital, that’s at odds with the specificity shareholders want, he said, adding, “it only takes one or two noisy activists to make your life miserable.” And don’t expect them to reward companies that try to get it just right by doing a bit of everything with the cash. Whatever you do, getting a plan out there sooner rather than later seems like good advice when 75% of survey respondents said they have not yet received pressure to declare repatriation plans with greater specifics.

2) No allocation silver bullet. Goldman said no single decision about what to do with excess cash feels completely “great”: High earnings multiples make share buybacks less appealing; raising dividends carries risks if the economy slows; debt repayment isn’t popular with most shareholders; and acquisitions of “inorganic” assets risk overpayment, while making organic investments begs the question of why you didn’t do it before. One member said M&A was her company’s first choice if the right target can be found; another said her company won’t “compromise” its smart balance sheet for M&A. Some members said they’re using tax reform to strengthen balance sheets, while one said it has sparked a “dramatic unwind” of the balance sheet as the company becomes a net debtor.

3) Credit rating agencies want clarity. Rating agencies, like shareholders, expect a detailed explanation of how US tax reform proceeds may alter financial policy and capital plans. If these are judged inadequate, agencies will fill in the blanks with conservative estimates and haircuts to prompt greater disclosure. They view their role as representing bondholders, who already know that they are going to be left out of the party being enjoyed by shareholders. A Moody’s pharma analyst said the reduction in interest deductibility under the tax law is a negative for highly leveraged corporates. A tech analyst from S&P said the firm views tax reform as negative because of the depletion of cash it will bring about. Meanwhile, more than one tMega member is hoping to avoid any credit upgrades resulting from increased cash flows. One treasurer said his company calculated how much capital it needs to deploy to avoid an upward revision that would signal to the market it was moving to “a more conservative financial profile” because activists might then agitate for higher returns of capital to shareholders.

4) Repatriation doesn’t mean all cash is untrapped. A tax expert from KPMG told members, “It’s not as easy as you may have hoped to get the cash back that was trapped outside the US.” One treasurer hopes the market understands that some cash will still be trapped—the US tax code is not the only factor determining what cash can be repatriated when. Plus, the hastily written US tax legislation has some errors and conflicts with the existing code governing international taxation, so simply bringing back cash may not even be fiscally smart. One treasurer called repatriation “a bit of mixed bag” because of the expense of bringing cash back and changing ownership structures.

5) Expect a lot of friendly dialogue with your tax department. The tax expert described the complexities of the new tax law as a “spaghetti bowl” of issues to unwind as tax departments grapple with how new measures like GILTI, FDII and BEAT interact with old regime measures governing Subpart F income and other rules. As one tMega member who oversees both treasury and tax puts it, “the combination of the new and old systems does not operate as a conceptually coherent whole. As a result, applying the new rules produces a lot of seemingly arbitrary and counterintuitive results.” Therefore, he says, “analysis and conclusions are necessarily specific to each company’s facts and circumstances.”

OUTLOOK

Goldman Sachs expects the amount of shareholder activism—including campaigns focused on balance sheet issues—to increase over the course of 2018. The amount of time activists give will depend in part on operating performance, share price performance and what’s been communicated so far. Other institutional investors, according to BlackRock’s chief equity strategist, also want to see strong earnings continue into next quarter, and she said that will help put any use of proceeds in a positive light. Treasury, meanwhile, will have to be patient as tax departments take the lead. The tMega member in charge of both groups put it like this: “Tax will in most cases need to go first. The money issues will be dictated by tax consequences, which will in turn be dictated by evaluating and making changes to the legal structure. All of that will take a while for complicated companies to sort out. Treasury issues will then come in the next wave.”

Plotting Pension Moves

Several tMega companies made significant pension contributions (ranging from about $600 million to $5 billion) in late 2017 or have announced plans to do so in 2018, (yes, there’s still time) to benefit from larger deductions under the old, higher tax rate. Members are also pushing forward with efforts to de-risk pensions by moving more money into fixed-income investments and, in some cases, by offloading risk to an insurer or otherwise annuitizing their pension liability. And the de-risking calculus is changing as interest rates rise.

Blockchain Benefits, Cybercrime Defenses

KEY TAKEAWAYS

1) The time is still right to make contributions. Companies on calendar fiscal years have until Sept. 15, 2018, to make contributions to qualified pension plans (that are also on calendar years) and maximize the contribution deduction under the old, 35% corporate rate. Most companies on non-calendar years have even more time to make contributions and receive the higher deduction.

2) The case for de-risking strengthens. More than one member mentioned de-risking pension plans as a top priority, continuing a theme the group discussed in detail last year. As Goldman Sachs pointed out in a recent note, increased pension contributions lead to higher funded ratios, “which may be a catalyst for more de-risking activities.” These activities, the firm notes, may include boosting allocations to long-duration fixed income as well as transferring liabilities to a third-party insurance company.

3) Pension questions remain. One issue members with pension responsibilities face is how overfunded they want a plan to be as interest rates go up because of the issues raised by surpluses. And one member whose company still sees its pension as a differentiator attractive to employees asked whether offloading a pension to an insurer really eliminates the liability. Another member answered, “If something goes wrong, employees/retirees are still going to name you in the lawsuit.”

OUTLOOK

Several members will be connecting and exchanging knowledge on pension issues going forward, including one who just inherited pension management. Among the issues to keep your eye on: More companies are contemplating the feasibility of shifting elements of nonqualified plans to qualified plans and optimizing the risk vs. tax deductibility trade in the process. Each company has a different wrinkle with its plan (e.g., one has a complicated profit-sharing arrangement imbedded in it), and these distinctions and differences mean that members will take different steps on their pension path.