Bristol-Myers Squibb Co.'s $275 million write-down on auction-rate securities partially collateralized by subprime mortgages was more than just the biggest loss by a nonfinancial company related to subprime investments: It has become the stimulus to reopen the debate on whether corporate treasuries should operate as a cost center or, on the other end of the spectrum, a profit center. Jeff Wallace, managing partner at Greenwich Treasury Advisors, sums it up: "Is it treasury's job to take trading risks to bolster the bottom line, or should it be assuming a more conservative posture of preserving capital and keeping the company's cash liquid and available?"
That question is reverberating in e iboardrooms and C-suites around the country, as directors and executives question their roles as cash managers. The pendulum has swung back and forth over the years on the issue–for instance, taking a sharp swing towards the conservative after the bond default by California's Orange County. With the cash buildup in the years since 9/11 and the Enron Corp. debacle, treasurers have been increasingly placed between the need to manage risk and the equally compelling requirement to produce a better return for shareholders. When economic times look rosier–and the need for a cushion seems less, the impetus has been to more actively invest these liquid assets either by sinking money back into the enterprise in R&D, capital investment or M&A; bolstering the stock price through higher dividends or stock repurchases; or investing in slightly more risky short-term investments. "These [strategies] all play into the overarching theme of trying to derive increased value for the company," says John Tus, treasurer of Honeywell International Inc.
One of the options that many companies pursued in the quest for better yield was the same auction-rate securities (ARS) that Bristol-Myers lost its shirt on. Although ARSs have been safely traded for years and few have led to a Bristol-Myers-type meltdown, the drug company's loss has some finance departments reconsidering the risks. Among the nonfinancial corporate names already reporting balance sheet hits from the subprime meltdown are Ciena, Lawson Software, 3M and U.S. Airways. The losses were more restrained than Bristol's–$13 million for Ciena or two cents on earnings per share for Lawson–either because the company's didn't invest as much or move faster to liquidate when subprime started looking shaky.
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Not all companies took the bait of what one banker estimated as a premium of 300 to 400 basis points on some ARSs. Honeywell, the 2007 Overall Excellence winner of the Alexander Hamilton Award, is an example. Treasurer Tus says it wasn't worth the risk. "To the extent that you have cash on balance sheet," he says, "it is important to develop an investment policy that everyone feels comfortable with."
The debate over treasury's role raises strong feelings among treasurers. "Our job is to protect the capital of the company," says Tim McDannold, the treasurer at Diebold Inc. "I would be concerned if the treasury were operated as a profit center, because it would push the organization to go beyond the border of investment policy as defined by our investment committee in conjunction with the board."
The posture of a treasury doesn't have to gravitate to the extremes. Greenwich Treasury's Wallace suggests that most treasuries–particularly the best practices ones–fall somewhere along the spectrum between profit center and cost center, either in the role of service center or value-add center. Each of these, he says, suggests a much more active treasury but one that is not necessarily taking on the same financial risks as a brokerage might. "But it's like arguing about religion," says Wallace. "There is no single right or wrong answer."
For Bristol-Myers, the debate is likely to get heated as well. Consultants speculate that the choice to invest in ARSs was likely driven by Wall Street pressure to boost earnings after one of its biggest money makers Plavix took a hit from generics that were dumped into the market. A banker who asked to remain anonymous was sympathetic. "If a company has $1 billion in cash, potential gains of $37.5 million outweigh the possibility of taking even a $10 million writedown," he says. The problem was the writedown turned out to be more than 30 times that number.
Bristol-Myer's biggest sin apparently: relying on Standard & Poor's and Moody's triple AAA ratings, says Tony Carfang, a partner at Treasury Strategies inc. "If a company decides to manage a portfolio on its own, it better do the research itself," he warns.
There were other missteps. Treasuries that opt to be profit centers also better diversify their portfolios and buy securities from multiple dealers that can give you different views of the market, says Carfang. Better yet, he recommends avoid ARS-type investments, which can be illiquid if auctions fail for lack of bidders. "These instruments are structured with maturities ranging from 10 to 30 years with no put-back to the investor," he says. "Thus, the structure of the security does not provide for liquidity for terms less than the original maturity."
For now, consultants reckon, boards and treasurers will take a more conservative stance. "Treasurers don't get high-fives if they do a few basis points better, but they can get fired if they lose money," says the banker. They will likely make use of the time to evaluate how best to invest idle cash, possibly reinvesting it in the company, repurchasing shares or providing dividends.
Investment banks that issue or sell ARS products, not surprisingly, take issue with Carfang's blanket dismissal of these securities. "On balance, as long as companies account for this properly, they usually do come out ahead," says Peter Jankovskis, chief investment officer of Oakbrook Investments LLC. "Even if they look foolish in the short-run, by writing off losses on continuing investments, they can hold the securities until they pay off."
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