When companies have too much cash

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Rahul Bajaj has caused a flutter "" again. A few days back he talked about separating the company from some of its cash, ostensibly to obtain a better valuation for the core business.

The idea is that existing shareholders will get proportionate stakes in a new demerged investment company. Most analysts were not thrilled with the idea, and have expressed a preference for a buyback of shares or higher dividends.

If you want to grow your business, analysts are the last people you should ask for opinions. For them, short-term cash in hand is always better than even more cash in the future.

But if you are an entrepreneur, buybacks and return of cash mean one of two things: there are no further opportunities for profitable deployment of capital, or you want to reward shareholders directly since the markets have failed to do so.

Neither is the case now. Most analysts agree that the management of Bajaj Auto has finally got its act together. Moreover, the markets are in fine form. Result: the company's market capitalisation has more than doubled over the last one year. The long-term future looks good, too.

The two-wheeler business is not only growing, but it is also segmenting steadily "" which suggests that companies need to invest more in creating new products for the segments that are now flowering. Bajaj's Pulsar is a case in point. With competition increasing, companies have to invest more aggressively, not less. It's good to keep some cash where it is accessible.

I have no quarrel with anyone who believes Bajaj is a no-hoper and hence should return cash to shareholders before it disappears. But that is just an opinion. I am sure there are other investors who see a global future for Bajaj. The management clearly does not plan to roll over and play dead.

If it believes it can invest its Rs 2,500-3,000 crore cash hoard to improve its future earnings, it has the right to do so. Not long back, HLL issued free debentures to its shareholders instead of dividends because it wanted to keep the cash for possible acquisitions, if the need arose. There's no reason why Bajaj can't do so, too.

The basic issue remains: What should companies that are surplussing huge amounts of cash do with the moolah? I think it is always a good idea to keep excessive cash some distance away from the company that is producing it.

Two reasons why: One, having too much money in the bank gives a company no reason to take risks, or work hard to add value to shareholder capital. And two, even if it seeks to invest the money, it should understand the true cost of capital. Companies that bank their surpluses seldom realise the opportunity cost of the capital they own or use.

It is a moral hazard, one that companies should seek to avoid. This, in fact, was precisely the problem with Bajaj Auto a decade back, when its rivals were steadily gaining marketshare. The huge size of Bajaj's cash hoard made its rivals look puny in comparison.

As the management slept, Hero Honda was beavering away in motorcycles. Bajaj started fighting back only when Hero Honda was close to becoming No. 1 and the management suddenly realised that the cash hoard could quite quickly disappear in the new situation.

Today, Bajaj has not only Hero Honda and TVS to contend with; it is facing 800-pound gorillas like Honda and a rejuvenated Yamaha, each of them capable of giving Bajaj a run for its money.

In such a situation, Bajaj needs to get even more aggressive "" in terms of investing more in R&D, creating an international presence, and global acquisitions "" if opportunities present themselves. It's thus not a bad idea to hive off the investment arm into a new company from which it can borrow at commercial rates "" when it needs to.

Why put the money in an associated company if you are anyway going to borrow at commercial rates? Might as well pay out the money to shareholders and borrow it from bankers later. No quarrel with this argument. But putting the money away in an associate company is better than keeping the money within Bajaj Auto since it reduces the moral hazard.

Besides, the fact is an investment company can get into new finance-related businesses that can provide shareholders a hedge against the main two-wheeler business. It's worth recalling that today GM and Ford make more money from their financing business than their manufacturing one.

Most important, when investment opportunities come unexpectedly, having a cash hoard in-house could be an advantage rather than a disadvantage.

All in all, Rahul Bajaj may be doing the right thing by his company and his shareholders. There can always be two views on how the money should be used, but he has a right to make this call. Investors who disagree can anyway make an exit through the markets.

rjagann@business-standard.com