End of 2018 it was finally done. The Swedish telecoms operator Telia Company AB managed to get rid of one of its most unloved subsidiaries. “It is satisfying that we are able to announce an agreement to sell Ucell in Uzbekistan.” is Johan Dennelind, CEO of Telia quoted in the December 5 press release. And from the viewpoint of this date this statement is even correct as the company has already anticipated the bad outcome of the selling process and written down parts of the asset before.

However, when looking at the naked valuation metrics, the deal was not at all a success. Eventually, Telia sold the unit for ca. 215 mio USD, but the actual net cash balance of the company was ca. 270 mio USD. So, not only roughly 50 mio USD of annual EBITDA power have been handed over to the Uzbekistan state but also an additional net 55 mio USD cash. While the deal is not a highly material transaction for Telia, it’s strange characteristics still forced the company to communicate that currently all components of Ucell are still included in the credit ratio calculation and once they are removed (after the deal) the net debt / EBITDA ratio of the company will increase by 0.1 points – from 1.1 to 1.2.

Admittedly, Telia’s Uzbekistan activities were not at all a flagship of corporate governance and CSR in the past. In 2017, the company had to settle a major multi-year bribery case by paying fines of nearly 1 bn USD. It might be that this still was a thorn in the local government’s side (even after the settlement). Or it might be that there were other (perhaps good) reasons for why the cash had been locked in Uzbekistan – I admittedly do not know this particular process very well. But all this is not the problem. The problem is Telia’s communication of the credit ratios – in particular the inclusion of components that do not have an economic meaning for the company.

To understand this, some further explanation is necessary: When talking about Net Debt / EBITDA or similar credit ratios, but also when performing business valuations, analysts are nearly always confronted with the existence of a more or less meaningful cash position on the balance sheet. Often this position is seen in its entirety as a highly liquid asset that increases the value of the company (all other things being equal) and that can be used to service the debt. But this point of view is deceptive in many cases. In fact, cash can have so many different faces. And so before including it into financial analysis it is first necessary to find out more about the true nature of the cash position.

Below we provide a non-exhaustive list of some of the most often found different characteristics of cash – together with some advice on how to deal with each of them in financial analysis.

  • Cash in countries that have capital transfer restrictions

This is the Telia case. Repatriation of cash is not at all easily possible from many countries. This might be due to political or regulatory restrictions, non-convertibility of currencies or an excess-taxation of outflows. Often this is somehow related to infrastructure or commodity business models. E.g., the Democratic Republic of Congo, where more than 60% of world’s cobalt supply (still a highly essential ingredient for electric batteries and hence a driver of electric vehicle growth) is mined, has announced a new mining code in 2018 with several conditions on cash repatriations for companies such as commodity giant Glencore Plc. Furthermore, capital transfer restrictions in Angola and Zimbabwe are leading to ballooning cash balances in these countries without meaningful possibilities of extraction for companies such as the South-African container and packaging producer Nampak Ltd. But South-Africa itself is also taking care of monetary transactions of foreign companies. The South Africa Reserve Bank is to approve every single one-off repatriation of cash, which makes a smooth cash flow between countries quite difficult, as companies such as mining company Anglo American Plc. have experienced.

But this topic is not regionally restricted to Africa. For almost two decades now, Spanish telecommunication company Telefónica S.A. has to live with the risk of repatriation restrictions for its Latin American subsidiaries. Ever since the famous “Operation Veronica” (the buyout of its Latin American minorities in 2000), the company has to deal very cautiously with cash transactions back to Spain. From today’s perspective there is still a non-immaterial part of group cash basically trapped in the Venezuelan and Argentinian subsidiaries. This is also one of the reasons why Telefónica wants to exit some of the Latin American operations – a similar learning curve as Telia’s.

Or take the European building material companies, in particular (but not only) LafargeHolcim Ltd., that also suffer material cash repatriation restrictions from their activities in  countries such as Algeria, Argentina, Russia and China. In their case the fact that they run many of their local subsidiaries with often very high minority positions (to be discussed below in detail) is further aggravating the problem.

But not to be misunderstood: There might be even good reasons for such regulations. It is not about complaining. It is about taking all this properly into account in financial analysis.

Hence, for valuation reasons these cash balances should be treated with a big discount – if they can be taken into account at all. For credit analysis it is worth separating two cases: a) if the company has foreign debt in this country, then this cash is a reasonable tool for servicing this debt (unfortunately rather rarely the case) but b) for the home debt these cash balances are basically meaningless. They will certainly not be able for transfer exactly at the time when they are needed.

For our initial Telia example this means that the cash in Uzbekistan (and also some other countries) should have been stripped out of the Net Debt calculation long before the deal is done. This is even more so the case as the repatriation problems have been known at least since the exit decision was made in 2015.

  • Cash that would be taxed in Case of a Retransfer to the Home Country

Not only the foreign countries restrict cash transfers. Often it is also the home country that taxes the cash in case of repatriation. Several countries do this and hence it is worth having a closer look at the home country tax rules for companies with material cash abroad.

Interestingly, the big repatriation tax country USA changed its tax laws recently to a mandatory tax on foreign liquid assets (away from a taxation only in case of cash repatriation). This should help bringing back some of the huge cash balances that US companies didn’t dare to repatriate in order not to get taxed for it.

For analytical reasons it makes sense to determine an after-tax cash value. Transfer is not per se restricted here, it is only quite expensive.

  • Cash in Escrow Accounts

In particular in relation to pension liabilities and (potential) legal fines or payment duties, cash sometimes has to be held by companies in escrow accounts. This means, it is particularly reserved for a certain purpose.

For analytical reasons, this cash cannot be counted. It is not available for dividend payments or debt servicing. However, for valuation reasons it is important to also not taking into account the respective dedicated liability that the cash is reserved for.

  • Cash in Subsidiaries on which Access is not (easily) possible

On a consolidated balance sheet we can see the cash position for an assumed 100% ownership of all subsidiaries with a holding >50%. In economic reality, companies often only have access to a smaller part of this because of outstanding non-controlling interests. For valuation reasons it is worth to only take the economic cash position into account.

For credit analysis one additional aspect becomes relevant. In Germany, for example, a holding company has no direct access to the cash flows of a subsidiary if there is no domination agreement in place (Beherrschungs- und Gewinnabführungsvertrag, requires a 75% AGM-voting). This means, without domination agreement the cash cannot be used for debt servicing of the mother (however, it can be used for debt servicing of the subsidiary per se) except for the dividend payments received. With such an agreement, however, the cash can freely be used by the mother company. And this is not only a German thingy. In other countries, similar rules apply.

A famous example of this cash access restriction without a domination agreement was the 2005 to 2009 attack of Porsche AG (later Porsche SE) on Volkswagen AG. Porsche’s idea was to debt-finance a position build-up to 75% of Volkswagen and then (with a domination agreement) using the big cash amounts of Volkswagen to stabilise the financing position of the group. However, when Porsche stepped over the 50% hurdle in early 2009, time was already playing against them. The financial crisis that broke out only a couple of months before has left its mark and has made banks highly cautious about their credit engagements. Banks now continuously tightened the thumbscrews on Porsche, prolonged an existing loan only after very long negotiations in spring 2009, and made clear that a 2010 maturing tranche will only be up for refinancing if the cash situation improves. For Porsche, however, this was not enough time to get to the desired domination agreement and so they finally had to give up their big acquisition plan.

Another aspect of the restricted access to the cash of subsidiaries is that even the cash that can be counted as beneficial for the mother company might sometimes take very long to arrive at where is should be. An example for this is Italian utility company Enel S.p.A that had a quite interlaced corporate structure with many subsidiaries and subsidiary-subsidiaries (in particular in Latin America) before 2013/14. In this situation it sometimes took several years until the dividend of a generation unit found its way via dividends of the intermediate holding companies up to the mother company Enel S.p.A. The 2013/14 restructuring, however, has clearly improved the intra-company cash flow situation (and led to a material reduction of the “holding discount” of Enel’s stock price).

  • Prepayment-like Cash

Cash in the form of prepayments cannot be used for debt servicing from an analytical point of view – be it for long-term projects (such as plant building and other construction works) or on an ongoing short-term basis (such as travel agencies).

A nice example is French catering group Sodexo S.A. which also runs a so called “Benefits & Rewards” business, which basically is about selling (tax-advantaged) vouchers to companies – here is the cash inflow to Sodexo – which give it to e.g. their employees. The employees, in turn, pay their lunch etc. with these vouchers and the restaurants or similar give back the vouchers to Sodexo which pays for it (here is the cash outflow). Sodexo is always running a huge cash balance due to this pre-paid vouchers business, but it cannot be touched for credit servicing reasons.

For valuation reasons, however, this cash has a positive value although it cannot be paid out as a dividend directly: Simply because it earns some interests. But two things are important to take into account: a) take care to not double count its value if the proceeds of this cash are already part of the forecasted free cash flows and b) there might be a timing mismatch between the risk free rate applied in business valuations in general (long-term) and the effective one for the cash investments (short-term, revolving). This can lead to slight valuation discount of this particular cash position.

  • Cash restricted for Doing Business

And finally, a certain portion of the debt is simply necessary for doing business. The concrete amount differs a lot from one business model to the other. But there is almost no business which can be run at zero cash.

This cash restricted for doing business cannot be used for ongoing debt servicing duties. However, it can be uses in case of temporary financial hardship. For valuation reasons it still has a value as long as it earns some interests. Hence, a full exclusion of this restricted cash from our valuation models – as is often seen in practice – is certainly not appropriate.