Case Review: Linear Technology
Linear Technology was based out of Silicon Valley and founded in 1981. The company specialized in design. industry and selling of parallel integrated circuits. Linear enjoyed a diversified client base. with 33 % of its concern coming from the communications sector. 27 % from computing machines. 6 % from automotive. and 34 % from assorted other applications. With their focal point on the parallel section of the IC sector. which was characterized by usage designed merchandises. it was imperative that Linear hires and retains talented people who were accustomed to out-of-the-box thought and who could readily develop advanced techniques and merchandises that would maintain them competitory.
Traveling IPO in 1986. Linear operated with a modest CAPEX. Additionally they enjoyed low obsolescence of equipment and techniques. This combined with their low R & A ; D disbursals led to borders that exceeded that of viing digital IC merchandises. This is supported by Linear’s 7th place positioning on the Philadelphia Stock Exchange Semiconductor Index ( SOX ) .
Linear’s net income was at its highest in 2001. when planetary engineering disbursement was at its highest. and its lowest gross revenues the undermentioned twelvemonth. They still maintained positive hard currency flows and strong borders ; this was accomplished through assorted mechanisms such as cost film editing aided by their variable cost construction. As of 2003 Q3. Linear was emerging out of the recession with strong financials. However. top line gross revenues and net income remained lower than their high point in 2001. Due to political agitation throughout the World. the hereafter of the tech industry remained ill-defined. Year over twelvemonth growing in 2003 when compared to 2002 was good. but the company didn’t see a clear way to making 2001 degrees. At the same clip. they didn’t want to give borders in new markets like Asia.
By 1992 Linear’s direction was comfy in their ability to prolong future hard currency flows. holding been hard currency flow positive since IPO. and began publishing dividends of $ . 00625 per portion ( payout ratio: 15 % ) . In 2002 LLTC continued publishing dividends. despite the higher payout ratio ( 27. 24 % ) . as they didn’t want to lose favour with investors. It is likely that Linear viewed dividends as a manner to remain in the portfolio of common financess and EU investors who strongly favored dividend-paying stocks.
Simultaneously. Linear besides began to purchase back portions when involvement rates were low or/and when market rating of Linear stock was low. They were disbelieving about paying out all or more of their hard currency in dividends as this could signal deficiency of growing potency. It is noteworthy that many institutional investors held Linear stock. largest among which was Janus Capital. Linear wanted to be certain to direct positive signals to their investors. With a big hard currency balance ( $ 1. 5 billion ) and no debt. Linear was at a hamlets – they needed to cognize what to make with their hard currency. Their options were: 1 ) Invest in new undertakings. 2 ) Payout via dividends and/or redemptions. and 3 ) Save it for future investings in invention and variegation. In this P per. we will analyse three different attacks in make up one’s minding
Linear’s payout for Q3.
Approach – 1 Cent Dividend Increase
The analysis below assumes the determination to buy back 165. 7 million in stock will non be adjusted. The determination to be made is to either raise our dividend by one cent per portion. or leave the 3rd one-fourth dividend of. 05 per portion integral.
Historically Linear has non increased dividends in Q3. so a conservative attack for the board would be to O.K. the continuance of the dividend policy from Q2. Continuing the position quo of. 05 per portion. the payout ratio would set to 27. 48 per centum of Net Income. Increasing dividend by one cent per portion would increase the YTD payout ratio to about 29. 31 per centum for the three quarters ( Exhibit 1 ) . a modest addition.
At $ 0. 06 dividend per portion. the entire Q3 dividend payout will be $ 18. 7 million. which will still be considered little by our institutional investors. given our big hard currency place. The acceptance of the 1-cent addition will supply a full offering of 215. 70 million dollars back to our investors in the signifier of dividends and stock redemptions as shown below:
Paying the extra 1-cent would still be consistent with our long-run dividend scheme. but the entire bundle will non be aligned with the petitions of some of our largest investors.
Available Cash to Distribute
At this point it is of import to observe that the house will be paying out more to the stockholders via portion redemptions and dividends. than the house has available to the equity holders through its operations. This overpayment holds true if the house holds the dividend at. 05. or increases it to. 06. The house has generated a sum of 207. 5 million FCFE dollars. but would be taking to payout a sum of 215. 7 million given the determination to increase the dividend by one cent. Staying committed to the. 05 dividend reduces this figure by merely three million.
Cash Needs and Agency issues
Excess hard currency to turn to any unanticipated demands will readily be available by following the conservative one-cent addition program. Increasing the dividend to. 06 includes keeping on to about 100 per centum of a really big hard currency place. and hence provides small force per unit area to place such future hard currency demands.
Linear’s gross revenues are swerving upward since the 2002 diminution. but the immediate hereafter is still non clear. The acceptance of this conservative program would go on their scheme of systematically signaling a message of safety and consistence of hard currency flows to their investors. yet provide options for our disruptive times. Other utilizations for this hard currency such as improved employee inducements. preparation. and workplace betterments should besides be considered.
The drawback for following the conservative program without turn toing the concerns of Janus and other like-minded investors could signal that they are non rather ready to propose that their recent problems are behind them. If we do take this program. a carefully crafted message to turn to investor concerns should be communicated to investors every bit rapidly as possible. Additionally. other attacks such as erstwhile portion redemptions and particular dividends should be considered to turn to the concerns of Janus and other houses that portion their position on Linear’s current hard currency place. We address these in Approach 2. 3 outlined in the subdivisions that follow.
Approach – 2 Payout all of Linear Technology’s Cash 1
In this subdivision. we consider an surrogate payout scheme in which Linear returns all of its 1. 5 billion to its stockholders. by either ( a ) Paying a particular dividend of $ 5. 01 per portion. or ( B ) Buy backing about 50 million portions.
( a ) Particular Dividend of $ 5. 01 per portion
One end of the particular dividend will be to demo investors that Linear is in a good place and to purchase portions from Linear Technology is non comparable with the hazard usually associated with the purchase of portions from engineering companies. Additionally it signals to the market that Linear is serious about sharing its wealth with its stockholders. With these higher overall payouts. Linear Technology can make investors that have specific income ends.
Share monetary value
In instance of a dividend proclamation. demand for portions will lift. If investors know that a certain dividend sum will be paid. the portion monetary value additions by that sum ( Law of One monetary value ) . In this instance. the current portion monetary value is $ 30. 87 and dividend announced will be $ 5. 01 ; hence the portion monetary value semens dividend can be expected to increase to $ 35. 88.
1 Exhibit 4 shows computations for Numberss presented in this subdivision
Depending on the clip until the dividend is paid. non the whole sum of dividend is added to the portion monetary value. If there is still a certain period of clip until the dividend is paid. merely the net present value of the dividend will be added to the portion monetary value. It besides can be said that the closer the payment of the dividend gets. the more the sum of the entire dividend payment is added to the normal portion monetary value. That besides means that accordingly the market value of equity besides will lift.
At the twenty-four hours ex-dividend twenty-four hours the portion monetary value will drop below the degree of the pre-announcement twenty-four hours because the dividend as driver of the lifting demand had been paid. The extra value of $ 5. 01 that was is non portion of the portion value any more. The dividend. as portion of the equity. is paid to the stockholder. Therefore. the dividend policy as a whole will non be a decisive factor in the firm’s value.
However. in this scenario the payout ratio becomes a laughably high 945 % ( Exhibit-4 ) . which is really high compared to equals. ( Exhibit 2 )
By deploying capital through an increased dividend versus a portion redemption. direction is signaling that Linear’s stock is reasonably valued in the market. However. If Linear increases its dividend excessively much say by giving out all the hard currency as dividends. direction could signal to the market that it believes the company’s growing is decelerating and there are no new positive NPV undertakings for the company to put in.
However. this may assist direct a positive signal that the company is confident about bring forthing positive hard currency flows for its operational and investing demands. Since net incomes of Linear Technology this one-fourth was far lower than that last twelvemonth. a immense particular dividend may assist the investors regain religion in the company.
Increasing dividend is besides a good manner to cut down bureau costs. With big sum of hard currency balance in manus. managers’ control over the capital becomes larger. Paying dividend to the investors is an efficient manner to acquire extra monitoring of the capital. and therefore do it less attractive to directors to put the money in undertakings that will cut down the benefits of the stockholders.
With this really high dividend. the company may pull more European and/or common fund investors. but it may by and large upset Institutional investors who do non hold revenue enhancement freedoms. Besides. the proclamation of a dividend may motivate older and poorer investors to purchase more of Linear’s stock. ( B ) Share redemption
Share monetary value and Shares outstanding
Linear can buy back 50. 7 ( 16. 23 % of common portions ) million common portions by passing all of its hard currency. When they do that. the figure of outstanding portions will be 261. 7 million. Historically. the stock monetary value of companies has risen following a portion repurchase proclamation as it can hike EPS. In this instance EPS increases to $ 0. 65. ( Exhibit-4 )
By deploying all of its capital towards portion repurchases. direction can signal the market that its stock really undervalued. Linear has had a positive hard currency flow over the old ages and they have an chance with a net hard currency of $ 1. 5 billion to bridge the supposed rating gulf by speed uping portion redemptions.
In drumhead. if the company goes out with a large stock redemption or particular dividend. it will direct a signal to investors that the company. is no longer a growing company. and stock value may diminish
Approach – 3 Payout 50 % of Linear Technology’s Cash2
Sing that direction does non hold a good line of sight into the hereafter at this point. paying out all of Linear’s hard currency may be a hazardous move. Hence. in this subdivision we look at a less aggressive attack that lies between continuing their hard currency balance ( Approach 1 ) and paying out all of their hard currency ( Approach 2 ) . In measuring this attack. we have assumed that Linear will necessitate to maintain up its quarterly dividend at $ 0. 05. and the balance of the hard currency after accounting for this quarterly dividend is available for either a particular dividend or a portion redemption.
The undermentioned subdivision analysis the consequence of paying out 50 % of the staying hard currency militias either in the signifier of a particular dividend of $ 2. 51 or by buy backing 25. 35 million portions.
EPS and Share Price
If we were to buy back portions utilizing 50 % of the hard currency. the EPS will increase from 0. 55 to 0. 59 near to the 2002 Numberss of 0. 62. Using a price/earnings ratio of 56. 53 in 2003 ( Exhibit-3 ) . we can gauge the portion monetary value to increase to 33. 65 with this increased EPS. cum dividend.
If we were to pay out a particular dividend of $ 2. 51 per portion alternatively. the portion monetary value semens dividend could be estimated to be a closely comparable $ 33. 38 ( Exhibit-5 ) . EPS will be 0. 55. really near to Q2 degrees ( 0. 54 ) .
The dividend payout ratio in the instance of the particular dividend will be near to 486. 3 % ( Exhibit-4 ) which is one time once more much higher than all of Linear’s equals ( Exhibit-2 ) . In contrast. with a portion redemption. the payout ratio remains at degree consistent with old quarters at 27. 5 % .
2 Exhibit 4 shows the computations for Numberss presented in this subdivision
Firm value and Shareholder wealth
Redemptions will assist relieve some of the dilution of the EPS originating out of options awarded to employees and directors. sing that Linear’s inducements for all employees include stock options. On the other manus. dividends will assist administer the wealth more equally among all investors. while redemptions cause an uneven distribution as the stockholders who do non sell will see a bead in book value of the portions. from
$ 5. 01 to $ 3. 23 ( unsmooth estimate based entirely on hard currency assets – Exhibit 5. Tax Clientele
With the new regulations that stipulate equal revenue enhancement rate of 15 % for Capital additions and OIC. there are no quantifiable advantages one manner or the other with regard to the determination to payout either in the signifier of a particular dividend or redemptions. There may nevertheless. be some psychological impacts to be considered depending on penchants of the stockholders. For illustration. if the huge bulk of stockholders belong to the older demographic. they may prefer it if the stock paid dividends.
Linear’s investors are used to acquiring a dividend. and seeing periodic redemptions. Additional payouts of hard currency aid increase ROE and cut down shareholders’ hazard premium. At current low involvement rates on hard currency ( as of 2003 ) . paying out at least some of the hard currency balance appears to be in the best involvements of the stockholders. Though high payouts may signal that the company is missing growing potency. it helps direct a positive message that the company is acute on sharing its wealth. This message of being a “cash-cow” is better compared to the image of a company that is stashing its wealth.
A speedy expression at Maxim’s financials indicates that they have started sharing their hard currency with their stockholders – in 2002 their hard currency returned was over 200 % of their FCFE ( Exhibit-2 ) . and their hard currency militias reduced by 455 million. They appear to hold used that hard currency in redemptions in an attempt to concentrate their wealth among a smaller figure of stockholders. at the same clip they managed to increase their top line Numberss significantly. even compared to 2000. By sharing half their hard currency with their stockholders. Linear will be able to set itself on par with this close rival.
Agency issues and other considerations
One clip particular dividends don’t demand to be kept up. so are basically similar to buy back in that regard. However. redemptions help hike EPS and prevent dilution. both of which have longer-lasting effects. In this regard a redemption may be better than a dividend. Equally far as bureau issues go. retaining 50 % of the hard currency place may non supply as much inducement to work harder on placing positive NPV undertakings. as using 100 % of the hard currency. but will work much better than retaining about all of the hard currency as in Approach 1.
Our Recommendation for Linear
Our recommendation to Linear is to keep position quo with regard to dividends – pay the quarterly dividend of $ 0. 05 per portion. and to purchase back 25. 35 million portions utilizing half the hard currency balance. Dividends consistent with old quarters of 2003. are recommended to avoid any inauspicious market reactions. while the company works on calculating out their scheme to increase top line gross revenues and net incomes to the 2000-2001 degrees or better. Canceling the dividend wholly or paying less than last one-fourth is non an option. as this would be perceived really negatively by the market. Historically. Linear has ne’er increased dividends in the Q3 compared to Q2 ; hence it is safe to keep a dividend of 5 cents per portion as in Q3. Additionally. as shown in Exhibit-2. Linear already pays more dividends compared to equals. including their close rival Maxim.
Paying out all of the hard currency may strip the company of the needed degrees of liquidness. Given that the parallel semiconducting material industry requires changeless invention and sing chances for new ventures such as come ining the Asiatic market. it is safe to presume that the company should maintain some
hard currency militias to account for terra incognitas.
Linear is good cognizant that they need to spread out their concern and happen ways to increase top line Numberss. so maintaining some hard currency. and supplementing it with capital from debt or/and equity markets is deserving looking into. This forms the footing of our concluding for urging the usage of merely 50 % of the hard currency balance to buy back portions.
Additionally. by buy backing portions. Linear will be able to still sufficiently signal to the market that the stock is undervalued. At the same clip. by keeping some of the hard currency balance. they to boot signal the being of profitable positive NPV undertakings for Linear to prosecute. Sing the industry features. and the stagnancy reached in top line grosss. Linear will necessitate to look at invention and new markets. both of which could convey dramatic additions in growing. In visible radiation of this. we are convinced that the EPS hiking consequence of a portion redemption is more valuable to Linear at this point. than the effects of an just distribution of stockholder wealth via particular dividends.