Letter from Lex: capital conundrums

Readers,

It is easy to tot up a company's growth rate or return on capital. These are measures of what is happening at present. It is much harder to assess whether a company is putting its money to work effectively. This is an exercise in guessing what will create growth and profitability in the future. Capital allocation was much on the Lex team's mind this week. To wit:

• King Digital's wobbly IPO points to one of the trickiest iterations of the capital allocation question. What is a company to do when a product becomes a tremendous, but finite, hit - such as King's Candy Crush mobile game? The money can be spent trying to pick the next winner, or sent back to shareholders. The former is tempting; the latter safe. And it is not just the creative industries that face this question. Coking coal producers and other miners had windfall profits at the peak of the commodity supercycle. They mostly reinvested the cash and that was mostly a mistake.

• Lucky is the company that gets to make its capital allocation decisions without meddling from the government. This week's news that Ofgem would toss the hot potato - a competitive review of the UK's big six energy producers - over to the Competition and Markets Authority reminded Lex what a tight spot UK energy companies are in. Stuck between income hungry investors and authorities who hate price increases, precious little capital is available for adding new generating capacity, which is desperately needed.

• In India, similarly, investment in domestic gas production is needed. But ahead of an election, gas prices increases have been put off. That makes it hard for Reliance Industries to put money into its projects in the Bay of Bengal.

• Exxon and Chevron look a lot alike. But where Exxon is focusing more on returning cash to shareholders and is bringing capital expenditure down, Chevron is more inclined to chase higher production and is holding capex steady.

• Five or 10 years ago, most global companies had a simple answer ready when asked where they were putting their excess capital: emerging markets, where the high returns are. This week, shares in Austrian bank Raiffeisen, a major lender in Ukraine and Russia, continued to sink. And the much ballyhooed Bumi plc partnership, a bold play on Indonesian coal, had its final death rattle. Returns and risk are linked, it turns out, and risk is not volatility, it is the chance that money is lost for ever.

•While we're on the topic of risk, Disney spent $900m of shareholder's money on a company that produces shows that play on YouTube. Lex is too old to explain this.

•The most important form of capital is the human kind, of course. Rupert Murdoch is pleased with his ability to produce the stuff: he has just promoted his sons to positions of greater power in his media empire. Is he guilty of misallocation? Probably. But this is what investors in 21st Century Fox have signed up for.

Spring is here. Enjoy your weekend.

Robert Armstrong, Head of Lex

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