Stay on cash; use it wisely.

In times of turmoil in the stock markets, companies with tons of cash in their balance sheets wake up to smell the coffee. They see acquisition opportunities abound and zoom in on assets going on the cheap. HP’s acquisition of EDS for $13.9 billion yesterday is a case in point.

So do activist investors like Carl Icahn, who was instrumental in Oracle's takeover of BEA Systems, has been buying Yahoo stock since Microsoft withdrew its offer May 3. Icahn reportedly owns about 50 million Yahoo shares, or about 4 percent of the company. The news comes just weeks after negotiations between the two faltered on price, after a protracted dance between Microsoft and Yahoo that started with the Redmond software giant's unsolicited offer on Feb. 1 for $31 a share. After the deal fell through because of Yahoo CEO Jerry Yang’s tough postures, Yahoo's shares have slumped as low as $22.97. That’s when Icahn moved in with gusto.

The HP deal means that companies with strong balance sheets - HP had nearly $10 billion in cash at the end of its most recent quarter - will be able to take advantage of the market's turmoil and snap up companies trading at steep discounts. Even with the premium HP is paying for EDS, the $25 per share price tag is still 17% lower than where EDS' stock was trading at about a year ago.

I look at a rough map of cash rich companies that could stir the hornet’s nest. The list includes not just the tech giants like Google, Oracle, Microsoft, Intel, Cisco or Apple, it also has companies having tens of billions of $ of free cash such as Exxon Mobil, Royal Dutch Shell, Chevron, Pfizer, Roche, Wyeth and Novartis. So far they’ve been using the cash for dividends, stock buyback or plowing it back in business. But when current businesses are shaky or as in the case of these Pharma majors where their drugs are about to go off patent, it’s prudent for them to look at biotech acquisition ops.

Makes sense.

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Smart way to debt freedom

The crisis in the global financial markets has raised bond yields to ridiculously high levels. Well that’s known to all. When defaults are likely, bonds quote at a significant discount to their offer price that pushes their yields up.

PE funds raise leveraged debt (on their portfolio firms) to fund their acquisition and the I-banks that lend to them will securitize that debt and issue bonds to recreate liquidity. These bonds mature at a future date and are to be retired by the future cash flows from borrower firms as they repay. This is the normal cycle.

But when you have a liquidity crisis, these bonds quote at a heavy discount owing to lack of demand and not because of credit worries. Now the original borrowers buy back these bonds at a discount and extinguish the debt. In effect, a company repays the debt that it owed to itself - an anomaly of sorts! This allows them to cut their interest bill, boost earnings and reduce their leverage, all on the cheap. Smart, isn’t it?

How does it matter to portfolio firms of PE funds? For private equity portfolio companies, buying back debt is different to the PE firms investing in debt from their own and other deals. The former is a way to retire debt cheaply; the latter is a new investment by private equity. Lender Banks are revolting.

Recently TDC, the Danish telecoms operator that was Europe’s biggest leveraged buyout when bought for €13bn ($20.8bn) by a private equity consortium in 2005, has unsettled its lenders by buying back €200m of loans at a discount of about 90-95 cents in the euro.

In particular, lenders worry that borrowers will choose to use excess cash to buy back debt at a discount rather than repay debt through formal channels at a par, as required by most standard leveraged loan agreements. The frustration of the lenders at the move by TDC, owned by Apax Partners, Blackstone, KKR, Permira and Providence Equity Partners, has caused the London-based Loan Market Association (LMA) to review its loan documentation guidelines.

Now you can’t have capitalism and fairness. Can you?

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Should we grudge the central banks?

I hear a lot more arguments against the central bank policies that inflate money supplies and its support to artificially-cheap credit that provides the fuel for speculative fever and instability.

On one hand, a liquidity crunch inspired sharp declines on many of the largest stock exchanges around the world. On the other hand, the Fed, the European Central Bank and the Bank of Japan pumped in liquidity worth hundreds of billions of dollars. Their idea was to restore calm by providing the means for borrowers to meet short-term credit needs. I have discussed it here earlier.

It may seem counter-intuitive but the good news was that the credit crunch was a signal that air was being released from stock market bubbles. It was a welcome event that excess liquidity behind most imbalances in the global economy was finally retreating. Interest rates are the single-most important conveyor of information — with these artificially low, investors felt their wealth had risen and got reckless.

Hey, but wait a minute… Central Banks intervention has as much to do with politics as it has to do with economics. When large number of people reel under debt mountains, someone has to help them ease the load. When Central Banks quietly ignore a subprime lending that overlooks all norms of credit assessments and individual’s capacity to repay debt, they’ve already precipitated a crisis – first sin. Now when it recoils, you grudge the central banks for infusing liquidity – the second. We're talking about lives here in millions - not just what makes good economics. Either you don’t commit the first sin or go cool with the second... can’t have it both ways. What do you think?