City & Business: Cash cow disease

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The Independent Online
MANY chief executives and finance directors will be keenly watching City reaction to the decision by East Midlands Electricity to pay out a bumper dividend. Like every water and electricity utility, East Midlands makes far more cash than it can usefully plough back into its core business. Like almost every utility, it tried diversifying, spent millions buying up unrelated businesses, and fell flat on its face.

Rather than risk any more fiascos, it is taking the safe course of handing back the money to shareholders. Other utilities have solved the problem in a different way, using cash to buy up their own shares. This boosts earnings per share but does not have the same tax advantages.

In some parts of the City, these moves have been heralded as little short of financial genius. They are nothing of the sort. They are an admission of failure - that these companies are incapable of finding new business opportunities and generating real returns from them. The strategy gives the lie to utility directors' claims that they should be paid as well as the executives of any other billion-pound business. Milking a cash cow does not deserve the same reward as building a farm.

Non-utility businesses with cash piles are increasingly being urged to follow the example of the utilities. Reuters has already done so. Great Universal Stores, Glaxo, Guinness, Sears and Argos have all been mooted as candidates for such tactics. GEC could still afford to do so, even if its bid for VSEL is successful.

Boots, which reports interim results this Thursday, is expected to re-affirm that it is philosophically happy with the idea. It is already cash-positive and will be awash with spare cash if it finds a buyer for its pharmaceuticals arm. It wants out of prescription drugs development. Its acquisition record is embarrassing: the pounds 900m Ward White purchase is still heralded as one of the truly awful deals of the 1980s. And its attempts at building a business from scratch have been patchy. The Children's World chain is only just scrambling into profit after eight years. Meanwhile the superb Boots The Chemist chain continues to throw off cash by truckload.

Boots and others may choose to pay out bumper dividends or buy up their own shares. If they can't invest successfully, it is the least of all evils. But they should be under no illusions. If they start to behave like utilities, they will eventually be treated as such - and banished to the stockmarket basement as lowly rated yield stocks.