The Knowledge Economy Cash Anomaly, Part 2
2012/12/16 2 Comments
This is a continuation of Part 1.
Option Value of Cash on the Balance Sheet
This theory of the cash anomaly posits that the returns from R&D are high, but also highly uncertain. Every once and awhile, the R&D of a company will produce a really high value project that requires massive investment and possibly acquisitions to use in combination with the asset. The problem with R&D as an economic asset is that it is very difficult to sell or even be exploited by organizations other than the organization that developed it. Unlike discovering oil, it is not clear even after discovery of a project that another firm could develop the project to create economic returns.
Because exploitation relies on unique capabilities inside the firm that are only poorly understood outside the firm, their economic value is harder to forecast. This violates the costless symmetric information condition of efficient markets is violated, unlike the projects of old economy companies, where the market has a reasonable expectation that it will understand the value of the project. This uncertainty introduces huge frictions if projects need to raise new capital. Therefore, if a company has R&D projects, the value of that project stream is greatly enhanced if the company also has a means of financing the projects that does not require subjecting those projects to the friction of market financing. These frictions are both directly financial in the form of more returns to new investors and intermediaries, and also temporal. In winner takes all markets, which many technology markets are, temporal costs are huge.
The option value of cash on the balance sheet could be huge, however, we would expect more tech companies to at least on occasion, expend all their cash and perhaps even borrowing capacity when they exercised options if this were the case. This is common in growing technology companies. Mature tech companies, rarely, if ever come close to expending their investment capacity.
I’m skeptical of this explanation. Why does Google need to hold enough cash to buy Yahoo or Facebook in cash, if they are never exercise the option to do so? When was the last time you heard that a company was undertaking a project with more than a billion dollars of expenditures in year one of the project? These kinds of companies can make acquisitions with stock, invest over time out of future cash flows, and they even have relatively low cost borrowing capacity should it be required.
Cash Poor at Home
Recently, much has been made of the U.S. companies that are parking cash overseas to avoid the tax when they repatriate it. Many companies are cash poor in their U.S. entity, but their consolidated balance sheet shows a lot of cash. This cash can’t be repatriated for distribution without a large tax bill. This is the worst of all possible worlds from a policy perspective, but it doesn’t seem to afflict tech companies as much as industrial conglomerates.
(BTW, Congress doesn’t need to capitulate to corporate demands for no tax on foreign earnings. All it has to do charge the companies income tax on their cost of capital for any overseas investments, then true up when the companies bring cash home. Particularly if the law slightly over estimated the cost of capital, or ignored the cost of capital on financial assets in the WACC calculation, so that repatriating funds usually triggered a small refund rather than a small bill, you could just sit back and relax and watch them all bring their cash home while still paying tax.)
Distress Costs
The final explanation I’ve heard offered is the idea that since most of the investments of a technology company are in workforce and R&D, the costs of financial distress are huge. Not only that, but the costs of financial distress can manifest themselves long before bankruptcy is close. If managers are cutting benefits or tightening R&D activites, and the costs are not properly captured by accounting frameworks. New talent goes elsewhere, the best old talent leaves, R&D becomes less creative, less real economic capital employed stealthily decreases without the accountants noticing. However, CFOs are smart, they know this–even if the accountants don’t. They keep cash on the balance sheet, employee benefits generous, and 10% time meaningful. This prevents the stealthy erosion of the real assets of the company, by the prospect of distress, which the intelligent and savvy workforce is acutely aware of even if they don’t conduct formal analysis.
But there is one more reason…
In part 3, I will outline how holding cash creates economic value, regardless of and in addition to, all these explanations. Go to Part 3.
robocosmist 
East Coast Chauvinism in Robotics: Time to Face Facts, Silicon Valley is Kicking Our Ass
2012/06/24 by Robert Morris Leave a comment
A cleaned-up version of this article became my first post on Hizook. http://www.hizook.com/blog/2012/06/25/east-coast-chauvinism-robotics-time-face-facts-silicon-valley-kicking-our-butt#comment-971
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I have lots of love for Pittsburgh in particular, but it really pisses me off when people on the East Coast repeat a bunch of falsehoods (See #8) about how Boston and Pittsburgh compare to Silicon Valley and the rest of the world. Many people in Pittsburgh and Boston—including people I call friends and mentors—smugly think that the MIT and CMU centered robotics clusters are leading the world in robotics. This is demonstrably false.
If leadership in robotics means forming companies, making money, or employing people, then Silicon Valley is crushing everyone—no matter what the Wall Street Journal editorial page says about their business climate. I’ve previously published an analysis of the Hizook 2011 VC Funding in Robotics data that shows that the Valley gets 49% of total VC robotics investment worldwide.
I’d now like to add an analysis of U.S. public companies (see bottom of the page). Basically, the ‘Pittsburgh and Boston are the center of the robotics world’ story is even more ridiculous if you look at where public robotics companies are located. Silicon Valley is crushing the other clusters in the U.S. at creating value in robotics and in building a robotics workforce in public companies. (A forthcoming analysis will show that this true worldwide and if you include robotics divisions of public companies not principally engaged in robotics such as Boeing and Textron.)
77% of the workforce at public robotics pure plays is in Silicon Valley companies. An astounding 93% of the market capitalization is headquartered in Silicon Valley and even if you exclude Intuitive Surgical (NASDAQ:ISRG) as an outlier, the Silicon Valley cluster still has twice as much market capitalization as Boston.
The public companies that I deemed to meet the criteria of being principally engaged in robotics, that they had to make and sell a robot, and not have substantial value creating revenues from businesses not related to robotics are listed in the table below.
The one company that I believe might be controversial for being excluded from this list is Cognex (NASDAQ:CGNX). However, while trying to do decide on whether to include them, I found their list of locations. They have three locations in California including two in Silicon Valley. That means that this ‘Boston’ company has more offices in Silicon Valley than in Boston. I’m not an advanced (or motivated) enough analyst to find out what the exact employee breakdown is, but combined with the fact that they make vision systems and supply components rather than robots, I elected to exclude them. I acknowledge that a similar case could be made about Adept (NASDAQ:ADEP) that just made a New Hampshire acquisition, but I have decided to include them and count them towards Silicon Valley. I do not believe that either of these decisions, substantively impact my finding that Silicon Valley is the leading cluster when it comes to public company workforce and value creation.
I’m hoping the people who are spreading the misinformation that Silicon Valley has to catch-up to Boston and Pittsburgh will publish corrections. I believe that this is important, particularly because I want to see Pittsburgh reclaim its early lead in robotics. So many robotic inventions can trace their heritage back to Pittsburgh, it is a real shame that Pittsburgh has not used this strength to create the kind of robotics business ecosystem that one would hope.
It is impossible for communities to take appropriate action if they do not understand where they stand. I hope that this new data will inspire the Pittsburgh community to come together and address the challenges of culture, customer access, and capital availability that have been inhibiting the growth of Pittsburgh’s robotic ecosystem before they lose too many more aspiring young entrepreneurs—such as me—to the siren song of California.
1,100
463
20%
2%
183
43
3%
0%
768
577
14%
2%
174
135
3%
1%
1,924
21,840
36%
88%
619
606
12%
2%
429
1,110
8%
4%
171
13
3%
0%
5,368
24,787
100%
100%
Filed under Clusters, Commentary, Economics, Finance, Public Companies Tagged with Boston, business, California, Clusters, drones, economic, Equity, financing, hizook, market capitalization, New England, Public Securities, robotics, Silicon Valley, Stock, VC, Venture Capital, workforce