The Knowledge Economy Cash Anomaly, Part 2

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.

Is a dollar worth a dollar on a tech company’s balance sheet?

Previously, dear reader, you and I have discovered that robotics companies are firmly entrenched in the knowledge economy and their assets look like other knowledge economy companies’s assets.  Robotics companies only hold only a limited amount of real assets but lots of financial assets.

As a related question, what is the value of the cash (and financial assets) on the balance sheet to investors?  There might be several issues with holding so much cash.  Particularly, money in a company should be employed making more money, ‘earning or returning’ as the saying goes.   Are there valid reasons to hold so much cash?  And if so, how should we value the cash that knowledge economy companies hold?

Cash Is King! (Or at least a founding father)

Bottom line up-front:  Valuations are always wrong.  What’s interesting is how they are wrong.  Assuming a dollar is worth a dollar is as good a rule as any, but is almost always wrong.  Nobody is really sure which way (too much or too little) it is wrong.  Below, is an elaboration of some of the issues with valuing cash which may come into play when valuing particular companies.  (And you thought that at least cash of all things had a fixed value  —  don’t we all wish!)

There are various criticisms of excess cash on the balance sheet, below are some of the most common.

1)  Holding the extra cash reduces returns, i.e. to buy into the business you have to buy a pile of cash beyond what is ‘necessary’ to run the business.  Further, the rate of return on cash has been essentially zero and certainly below inflation lately, so holding the portfolio the stock represents of a highly profitable business, plus cash must necessarily produce a lower expected return than just the business.

2)  Because of agency problems, management may be incentivized to use the cash to reduce volatility or ‘save’ the business if it falls on hard times, even if the investors could get a markedly higher rate of return in the market.  From an investor’s point of view this would be systematically wasting money.  Employees, customers, management, and trading partners might have a very different view.

3)  Holding lots of cash is said to signal that the company does not have profitable investment opportunities commensurate with the cash that it is generating and the company’s growth may slow in the future.  Further, holding lots of cash signals that you don’t know, or are ignoring, the traditional Anglo-Saxon business administration.  English speaking investors generally expect management to maximize monetary returns over the forecasting horizon and put shareholder interests ahead of all others.

Some countervailing points that you will often hear are along the following lines. 

A)  Although holding cash reduces returns, for a volatile security like a fast growing knowledge economy company, having cash on the balance sheet dramatically reduces volatility.  If investors want more exposure to the underlying business for the same initial investment, lever-up.  Since we are talking about cash holdings, buying on margin is almost a perfect antidote to management’s lackadaisical cash management policies if you feel that way.  [But seriously, who is their right mind thinks you need to lever-up when buying tech stocks?]

B)  Although management might ‘burn’ cash saving a failing business, which would be better redistributed to investors, more likely, they are going to have the flexibility to engage in acquisitions and new ventures without having to deal with the whims of the security markets.  [Has anyone seen a rational market lately?  Please let me know.]

Or has anyone read the Wall Street Journal?  Tech companies are routinely attacked for having their fixed life fund investors exit—Groupon and Facebook each got front page hatchet jobs over the past two days with nary a mention that these funds had been planning to sell now for, oh say, 8-10 years!  Talk about journalistic malpractice.  Would you want to go to the public markets in that environment?  I sure wouldn’t.  If I was management, I’d say that if investors are that irrational, I’ll keep the cash and do what they should have done with the money.

C)  Finally, although cash on hand may sometimes signal that the companies are running out of investment opportunities, it certainly signals to would be competitors that the said company is in a position to stick around for a long time and bitterly contest any erosion of their market position.  This may greatly enhance the value of the underlying business asset.

D)  This is a successful tech company.  It is run by the founders, for the founders (i.e. management).  If you don’t want the privilege of investing and taking whatever returns the founders deign to give, please step aside and allow the next investor to purchase stock.  But this isn’t really a justification.  Founders are investors too, especially once the company goes public, with theoretically the same motivations as other investors since their stake is highly liquid.

Further research on technology companies and their cash management policies should address the following issues:

I)     Are there structural reasons beyond the creation of new businesses and defense of existing businesses for technology/knowledge companies to hold lots of cash?  It does not occur to me that there is anything about a maturing knowledge business that seems to require massive amounts of cash.  Law firms and accounting firms do not seem to hold too much cash, but they are also typically private and can make much more drastic changes than public companies.

II)   Are there frictions between the interests of various classes of investors?  Particularly when there is a founder controlled/managed company, cash on the balance sheet is probably as good to them from a control perspective as cash in the bank and better from a tax perspective.  Should investment banks or others creating the classes of stock have new mechanisms to deal with this?

III)  What are the true limits on investment opportunities?  My firsthand observation has been that the greatest constraint on growth of robotics companies is management attention.  It may be that most technology companies have massively profitable investment opportunities, but management attention is engaged on current projects and hiring into the management circle is not that easy.  What is the needed resource to change this?  How can cash be used to obtain this resource?  Can it?  Is passion required?

IV)  Are there ways that management could resolve some of the market frictions that require them to hold lots of cash?  The public markets seem to mercilessly abuse tech companies—no they don’t look like utilities, but the highs and lows that they are pushed to seems unjustified—there just doesn’t seem to be enough new information about their future prospects to justify either one.  Can management take steps to make access to public markets, particularly debt markets more reliable?  Could banks make money by providing massive, typically undrawn, lines of credit that would provide much of the same protections to management?

U.S. Robotic Stocks: Speculators Wanted (the real kind, not the financial kind)

The first part of the robotic stock tracker is up.  The index is coming!

First observation:  It is amazing how volatile robotic stocks are and how much idiosyncratic behavior each stock has exhibited since the start of the year.   With this much volatility, one would expect robotic stocks to produce market beating performance over the long run, but they certainly haven’t done it so far this year.  In the short run, it is very difficult to value real assets that have uncertain financial prospects.  In the long run, I’m banking on an extremely bright future, powered by robots.

What cluster does a company with HQ in Boston but more offices in Silicon Valley belong to?

I’ve got more comprehensive data on public robotics companies due to some updates suggested over at hizook.  However, I’m at a loss as to how to classify Brooks Automation and Cognex.  They both make automation components for various kinds of industrial applications and they both have corporate HQ outside of Boston with two offices each (probably the legacy of acquisitions) in Silicon Valley.

At a loss as to how to classify them, I’ve made a new category for them on my charts.  If you have thoughts about how to get good acquisition data–especially as a lot robotics companies can be acquired in a transaction that is ‘immaterial’ to a 10-K/Q for public company–I’d love to hear them.

And here is the raw data.  Not all market caps were taken on the same day.

Surprise! Robotics Companies Are NOT Capital Intensive

Please allow me to blow your mind and overturn the common sense notion that robotics companies are capital intensive.  Comparing profitable, public, U.S. based robotics companies to a diverse basket of prominent public companies shows that robotics companies do not require a lot equipment and property to make successful businesses.

In fact, robotics companies have the least property plant and equipment of any of the companies I selected for comparison–which deliberately included such tech giants as a chip maker, an operating system maker, and a search engine giant.  Looking at capital expenditure and depreciation, the robotics companies are again among the leanest of the companies on the list.

The only companies that had such low numbers for CAPEX and depreciation had their assets tied up in very long term investments like real estate and aircraft manufacturing facilities.  Also, most of the robotics companies are still growing and may have their capital expenditures boosted as a percentage of revenues by their anticipated growth.  Take a look at the trend line.

Now what people may mean when they say that robotics is ‘capital intensive’ is that the marginal cost of goods sold for a robotics company is greater than $0/per unit that consumer web applications have–but if that’s what they mean they should come out and say it and not be sloppy in their reasoning.

Angels, VCs, and other investors are you paying attention?  Big plays are going to be made on relatively small bets.

As a Percentage of Revenue


PPE Depreciation









Intuitive Surgical














Robotics Median




Robotics Average




































Dominion Resources















Home Depot




Diversified Median




Diversified Average




Some notes on the analysis:

-Data comes from the companies last 10-K filing.  Some companies include different things in revenue (where possible I tried to exclude revenue from a financing arm), in deprecation (some include amortization of intangible assets), and capital expenditure (Intuitive, for example, includes the acquisition of intangible assets).

-I wanted to look at a diverse basket of public companies and tried to pick companies that might be similar in some ways to robotics companies but whose earnings would not be unduly influenced by robotic related income.  For example, I excluded offshore oil field services companies because they were too close to being robotics companies, but still not pure enough to get a good view of the diversified company.  I did include Disney (which does anamatronics), Boeing (which has a UAV making subsidiary), and Google (which has a robotic car division) because I thought the revenues contributed to the these companies by robotics related activities had no material impact on the financial metrics.  However, their tangential involvement in robotics speaks to their similarity to robotics businesses.

-Future analysis should look at some other places where capital use can be buried.  For example, Cost of Goods Sold can hide capital that is employed on the companies behalf further up the supply chain.  It is possible that current assets like inventory may also need to be higher for robotics companies.  Also, we should compare total assets and liabilities to the revenue generated to similarly sized public companies to see if there is a substantial difference.

East Coast Chauvinism in Robotics: Time to Face Facts, Silicon Valley is Kicking Our Ass

A cleaned-up version of this article became my first post on Hizook.


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.

Company (1) Ticker Employees (2) Market Cap $M (3) % of Employees % of Market Cap Robotics Cluster










Aerovironment NASDAQ:AVAV










Intuitive Surgical NASDAQ:ISRG















Stereotaxis Inc. NASDAQ:STXS










(1) Companies are U.S. public companies that have been identified by Frank Tobe’s or my own research as principally engaged in robotics
(2) Employee Count as of Last 10-K Filing
(3) Market Capitalization as of 6/24/2012

Better Coverage for Robotic Stocks

Unfortunately we’re still not a big enough industry that we get good news and analyst coverage on important events.  For instance, Hansen Medical (NASDAQ:HNSN) announced FDA approval of their new surgical device yesterday.  Expected perhaps, but still uncertainty reducing good news for the company, the stock should go up.  It does for a few minutes, then the market goes back to hammering them.   For a company of alumni from Intuitive Surgical, what gives?

I understand they are not growing, but it seems like they have the breathing room to perfect their product and growth does not occur linearly in these kinds of companies.  I’d love to see some good information on what the company should be valued at conditional on success and what the current market discount implies about the probability of success.

Check it out on Google finance:

Q1 2012 Conference Call Transcript: