HBS Case Review: Linear Technology
With their focus on the analog segment of the ICC sector, which was characterized by custom designed products, it was imperative that Linear ire’s and retains talented people who were accustomed to out-of-the-box thinking and who could readily develop Innovative techniques and products that would keep them competitive. Going PIP in 1986, Linear operated with a modest CAPE. Additionally they enjoyed low obsolescence of equipment and techniques, This combined with their low R expenses led to margins that exceeded that of competing digital ICC products.
This Is supported by Liner’s 7th seat positioning on the Philadelphia Stock Exchange Semiconductor Index (SOX). Liner’s net Income was at its highest In 2001 , when global technology spending was t its highest, and its lowest sales the following year. They still maintained positive cash flows and strong margins; this was accomplished through various mechanisms such as cost cutting aided by their variable cost structure. As of 2003 SQ, Linear was emerging out of the recession with strong financial. However, top line sales and net income remained lower than their high point in 2001.
Due to political unrest throughout the World, the future of the tech industry remained unclear. Year over year growth In 2003 when compared to 2002 was good, but the company didn’t see a Lear path to reaching 2001 levels. At the same time, they TLD want to sacrifice margins in new markets like Asia. By 1992 Linear management was comfortable in their ability to sustain future cash flows, having been cash flow positive since PIP, and began Issuing dividends of $. 00625 per share (payout ratio: 15%). In 2002 LILT continued issuing dividends, despite the higher payout ratio (27. 4%), as they didn’t want to lose favor with investors. It is likely that Linear viewed dividends as a way to stay in the portfolio of mutual funds and E Investors who strongly favored dividend-paying stocks. Simultaneously, Linear also began to buy back shares when interest rates were low or/and when market valuation of Linear stock was low. They were skeptical about paying out all or more of their cash In dividends as this could signal lack of growth potential. It Is notable that many Institutional Investors held Linear stock, largest among which was Janis Capital.
Linear wanted to be sure to send positive signals to crossroads – they needed to know what to do with their cash. Their options were: 1) Invest in new projects, 2) Payout via dividends and/or repurchases, and 3) Save it for true investments in innovation and diversification. In this p per, we will analyze three different approaches in deciding Liner’s payout for SQ. Approach – 1 Cent Dividend Increase The analysis below assumes the decision to repurchase 165. 7 million in stock will not be adjusted. The decision to be made is to either raise our dividend by one cent per share, or leave the third quarter dividend of . 05 per share intact.
Payout Decision Historically Linear has not increased dividends in SQ, so a conservative approach for the board would be to approve the continuation of the dividend policy from SQ. Continuing the status goof . 05 per share, the payout ratio would adjust to 27. 48 percent of Net Income. Increasing dividend by one cent per share would increase the YET payout ratio to approximately 29. 31 percent for the three quarters (Exhibit 1), a modest increase. At $0. 06 dividend per share, the total SQ dividend payout will be $18. 7 million, which will still be considered small by our institutional investors, given our large cash position.
The adoption of the I-cent increase will provide a full offering of 215. 70 million dollars back to our investors in the form of dividends and stock repurchases s shown below: Paying the additional I-cent would still be consistent with our long-term dividend strategy, but the total package will not be aligned with the requests of some of our At this point it is important to note that the firm will be paying out more to the shareholders via share buybacks and dividends, than the firm has available to the equity holders through its operations.
This overpayment holds true if the firm holds the dividend at . 05, or increases it to . 06. The firm has generated a total of 207. 5 million FACE dollars, but would be choosing to payout a total of 215. Million given the decision to increase the dividend by one cent. Staying committed to the . 05 dividend reduces this figure by only three million. Cash Needs and Agency issues Surplus cash to address any unforeseen needs will readily be available by adopting the conservative one-cent increase plan. Increasing the dividend to . 6 includes holding on to almost 100 percent of a very large cash position, and therefore provides little pressure to identify such future cash needs. Signaling Liner’s sales are trending upward since the 2002 decline, but the immediate future is still not clear. The adoption of this conservative plan would continue their strategy of consistently signaling a message of safety and consistency of cash flows to their investors, yet provide options for our turbulent times. Other uses for this cash such as improved employee incentives, training, and workplace improvements should also be considered.
Other Considerations The drawback for adopting the conservative plan without addressing the concerns of Janis and other like-minded investors could signal that they are not quite ready to suggest that their recent troubles are behind them. If we do choose this plan, a carefully crafted message to address investor concerns should be communicated to investors as quickly as possible. Additionally, other approaches such as one-time share buybacks and special dividends should be considered to address the concerns of Janis and other firms that share their view on Liner’s current cash position.
We Approach – 2 Payout all of Linear Technology’s Cash 1 In this section, we consider an alternate payout strategy in which Linear returns all of its 1. 5 billion to its shareholders, by either (a) Paying a special dividend of $5. 1 per share, or (b) Repurchasing about 50 million shares. (a) Special Dividend of $5. 01 per share One goal of the special dividend will be to show investors that Linear is in a good position and to buy shares from Linear Technology is not comparable with the risk normally associated with the purchase of shares from technology companies.
Additionally it signals to the market that Linear is serious about sharing its wealth with its shareholders. With these higher overall payouts, Linear Technology can reach investors that have specific income goals. Share price In case of a dividend announcement, demand for shares will rise. If investors know that a certain dividend amount will be paid, the share price increases by that amount (Law of One price). In this case, the current share price is $30. 87 and dividend announced will be $5. 1; hence the share price scum dividend can be expected to increase to $35. 88. Depending on the time until the dividend is paid, not the whole amount of dividend is added to the share price. If there is still a certain period of time until the dividend is paid, only the net present value of the dividend will be added to the share price. It also can be said that the closer the payment of the dividend gets, the more the amount of the total dividend payment is added to the normal share price. That also means that consequently the market value of equity also will rise.
At the day ex- dividend day the share price will drop below the level of the pre-announcement day because the dividend as driver of the rising demand had been paid. The additional value of $5. 01 that was is not part of the share value any more. The dividend, as part of the equity, is paid to the shareholder. Therefore, the dividend policy as a whole ill not be a decisive factor in the firm’s value. Payout ratio However, in this scenario the payout ratio becomes a ridiculously high 945% (Exhibit-4), which is very high compared to peers. Exhibit 2) By deploying capital through an increased dividend versus a share repurchase, management is signaling that Liner’s stock is fairly valued in the market. However, If Linear increases its dividend too much say by giving out all the cash as dividends, management could signal to the market that it believes the company’s growth is slowing and there are no new positive NP projects for the company to invest in. However, this may help send a positive signal that the company is confident about generating positive cash flows for its operational and investment needs.
Since profits of Linear Technology this quarter was far lower than that last year, a huge special dividend may help the investors regain faith in the company. Agency problems Increasing dividend is also a good way to reduce agency costs. With large amount of cash balance in hand, managers’ control over the capital becomes larger. Paying dividend to the investors is an efficient way to get additional monitoring of the UAPITA, and thus make it less attractive to managers to invest the money in projects that will reduce the benefits of the shareholders.
Tax Clientele With this very high dividend, the company may attract more European and/or mutual fund investors, but it may generally upset Institutional investors who do not have tax exemptions. Also, the announcement of a dividend may prompt older and poorer investors to buy more of Liner’s stock. (b) Share repurchase Share price and Shares outstanding Linear can repurchase 50. 7 (16. 23% of common shares) million common shares by pending all of its cash. When they do that, the number of outstanding shares will be 261. Million. Historically, the stock price of companies has risen following a share repurchase announcement as it can boost PEPS. In this case PEPS increases to $0. 65. (Exhibit-4) By deploying all of its capital towards share repurchases, management can signal the market that its stock very undervalued. Linear has had a positive cash flow over the years and they have an opportunity with a net cash of $1. 5 billion to bridge the supposed valuation disconnect by accelerating share repurchases.
In summary, if the company goes out with a big stock buyback or special dividend, it will send a signal to investors that the company, is no longer a growth company, and stock value may decrease Approach – 3 Payout 50% of Linear Technology’s Cash Considering that management does not have a good line of sight into the future at this point, paying out all of Liner’s cash may be a risky move. Hence, in this section we look at a less aggressive approach that lies between preserving their cash balance (Approach 1) and paying out all of their cash (Approach 2).
In evaluating this approach, we have assumed that Linear will need to keep up its quarterly dividend at $0. 05, and the remainder of the cash after accounting for this quarterly dividend is available for either a special dividend or a share repurchase. The following section analysis the effect of paying out 50% of the remaining cash reserves either in the form off special dividend of $2. 51 or by repurchasing 25. 35 million shares. PEPS and Share Price If we were to repurchase shares using 50% of the cash, the PEPS will increase from 0. 55 to 0. 59 close to the 2002 numbers of 0. 62. Using a price/earnings ratio of 56. In 2003 (Exhibit-3), we can estimate the share price to increase to 33. 65 with this If we were to pay out a special dividend of $2. 51 per share instead, the share price scum dividend could be estimated to be a closely comparable $33. 38 (Exhibit-5). PEPS will be 0. 55, very close to SQ levels (0. 54). Payout Ratio The dividend payout ratio in the case of the special dividend will be close to 486. 3% (Exhibit-4) which is once again much higher than all of Liner’s peers (Exhibit-2). In contrast, with a share repurchase, the payout ratio remains at level consistent with previous quarters at 27. 5%.