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U.S. small-cap firms look to spend tax savings on tech, not jobs

NEW YORK (Reuters) – A Texas-based chain of strip clubs would go on a buying spree. A growing technology company would move fewer jobs overseas. And a regional bank would boost its spending on cybersecurity.

These are some of the uses of the tax savings that small and medium-sized U.S. companies say they would pursue if the Trump administration and the Republican-controlled Congress slashed corporate taxes as promised.

Small companies pay the highest taxes and they would be the main beneficiaries of such a Trump windfall. Reuters contacted the 100 largest companies by market value in the benchmark Russell 2000 index of U.S. small and mid-cap stocks as well as another 50 in the Russell 2000 with no analyst coverage. None of the 17 companies that responded to Reuters queries mentioned boosting their headcount.

The administration has said the tax cuts would largely pay for themselves by spurring more investment and creating jobs.

But companies say they look to spend on technology that will allow them to improve productivity or make acquisitions rather than hire more workers.

“We want to be a company of the future, and technology is one of the key ingredients,” said Keith Cargill, chief executive at Dallas-based Texas Capital Bankshares Inc (TCBI.O), a bank with a market value of $4.2 billion. The tax cut would be a “huge plus” for earnings, Cargill said, but with little impact on the bank’s workforce.

The Russell 2000 companies tend to pay the highest effective tax rates now – an average of 31.9 percent, according to Thomson Reuters data – and would stand to gain the most if corporate taxes are cut to 20 percent from 35 percent as the Trump administration has proposed. 

For large companies in the S&P 500, the average effective tax rate is 28 percent, a reflection of a greater share of overseas business and more leeway in reducing their tax rates.

While few companies would discuss any details in public before outlining them to their shareholders, executives, chief financial officers and treasures say they are already starting to formulate plans for a tax windfall even if they are not certain whether and in what form it will pass.

Neil Hennessy, the chief executive of Novato, California-based Hennessy Advisors Inc (HNNA.O), a mutual fund company, told Reuters he was in “acquisition mode” and would keep looking for targets in the event of a tax cut passing.

STRIP CLUBS AND SHARE BUYBACKS

One of the first firms to publicly discuss a potential tax windfall is RCI Hospitality Holdings Inc (RICK.O), a chain of 40 strip clubs headquartered in Houston, Texas. Its chief executive Eric Scott Langan told analysts on Aug. 9 that a tax cut would allow him to buy more clubs and boost the share price, which he complained failed to reflect the firm’s organic growth.

The exterior of Rick’s Cabaret & Steakhouse is seen in New York City, U.S. October 7, 2017. REUTERS/Stephanie Keith

“I think that’s going to change and I think that’s when you’re going to see the multiple expansion come into play,” he said during an earnings call.

The tax cut would also affect companies which do not pay taxes now either because they are not yet profitable or are using past losses to offset their tax bills.

Paul Auvil, the chief financial officer at cybersecurity company Proofpoint Inc (PFPT.O), said that the $4 billion market-cap company expects to start paying taxes in 2021 when it no longer be able to offset past losses.

By then the corporate tax rate would need to sink at least below 27 percent, Auvil told Reuters. Otherwise Proofpoint would move its intellectual property to an offshore company in Europe, where corporate taxes are lower, which would mean hiring up to 100 back office staff there, said.

“These are jobs that have every reason to be in the U.S. but it will require tax reform.”

The prospects of a tax cut have helped push the iShares Russell 2000 ETF (IWM.P) up about 10 percent over the last six weeks, compared with a 3.7 percent gain in the fund which tracks S&P 500 .SPX.

If the tax package does pass, large companies will be more likely to buy back their own stock, while smaller firms will probably reinvest in their businesses, said Tom Forte, an analyst at New York based D.A. Davidson.

“These companies are going to take every incremental cost savings from a tax cut and invest it to keep up with the Amazons (AMZN.O) and Ubers,” Forte said.

For instance, Forte expects EBay Inc (EBAY.O) to spend most of the possible windfall on increasing its stock buyback program. A smaller company like Yelp Inc (YELP.N) would probably invest in artificial intelligence technology to better harness its website’s advertising potential, he said.

GrubHub Inc (GRUB.N), meanwhile, would spend more on its service that delivers from restaurants that do not have their own delivery staff, Forte said, while Groupon Inc (GRPN.O) would invest more in marketing and advertising.

Some smaller companies are also considering share buybacks rather any significant changes to their capital allocation.

Thomas Castellano, treasurer at drug delivery company Catalent Inc (CTLT.N), told Reuters that the $5.2 billion company would keep spending on maintaining its 35 locations around the globe and look for possible acquisitions. Any extra money would go to share buybacks and Catalent was unlikely to increase its hiring rate if a tax cut passes, Castellano said.

“We wouldn’t be adding to our headcount because that would affect our margins at a time when we would otherwise see them improving.”

Reporting by David Randall; Editing by Jennifer Ablan and Tomasz Janowski

Our Standards:The Thomson Reuters Trust Principles.

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