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By Ronald Fink
While free cash flow in much of the technology industry finished last year in relatively decent shape, a new study indicates that's likely to change-and change dramatically.
The study of cash flow trends at non-financial corporations in 20 major industries by the Georgia Tech Financial Analysis Lab found that at the end of last year, free cash flow margins (that is, cash flow after taxes, interest payments and research and development expenses divided by revenues) averaged 4.1% overall.
While that was down from a post-2001 peak of 5.1% in June 2004, an accompanying report said the margin had held up "reasonably well" in light of the recession, thanks to cuts in capital spending and working capital requirements. But the report also predicted that margins were likely to shrink going forward.
The software and services industry did substantially better than other sectors, with free cash flow margins of 9.6% at the end of the fourth quarter of 2008, compared with 11.9% a year earlier.
The authors of the report, Charles Mulford, an accounting professor at the university, and research assistants Jason Blake and Sohel Surani, noted that capital spending in the sector has remained relatively low and stable, at roughly 2% of revenue, during the past several years, after hitting a peak of 7.3% at the height of the dotcom bubble in 2000.
Similarly, free cash margins in the semiconductor and semiconductor and equipment industry clocked in at 9.1% at the end of last December, though that represented a sizeable decline from 12.4% a year before. The authors cited a sharp drop in industry operating margins that more than offset a decline in capital spending.
And in technology, hardware and equipment, cash margins fell by more than a third in 2008, to 4.4% at the end of December from 6.9% a year before. The report said that both profit margins and operating cash flow were to blame.
Among individual companies, Motorola's performance was particularly striking. The cell phone maker's free cash margin fell to negative .05% at the end of 2008 from a positive .95% a year earlier, as R&D expense increased while working capital fell.
Overall, the picture is likely to darken considerably for most tech companies. Mulford told CIOZone that the effort by technology companies to pare capital spending and working capital had kept free cash flow stronger than he'd expected. But he also said that, at this point, there was little left to cut. "They're not reinvesting for growth, and to what extent they can cut capex further without replacing worn out equipment is an open question," he said.
What's more, Mulford noted that free cash margins were about 50% lower during the previous recession in 2001 than they are now, even though that recession was much milder than this one.
As the report put it, "We continue to believe that during the current recession, free cash margin will likely decline to levels that are at or below those found in the 2001 recession."
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