Wednesday, March 6, 2019
Case Review: Linear Technology Essay
bilinear applied science was based prohibited of Silicon Valley and founded in 1981. The comp every surplus(a)ized in design, manufacture and marketing of analog interconnected circuits. match little-dimensional enjoyed a diversified customer base, with 33% of its business overture from the communications sector, 27% from computers, 6% from automotive, and 34% from various other applications. With their localise on the analog segment of the IC sector, which was characterized by custom designed products, it was imperative that linear hires and retains talented people who were accustomed to let on-of-the-box thinking and who could pronto develop innovative techniques and products that would keep them competitive.Going IPO in 1986, analog operated with a humiliated CAPEX. Additionally they enjoyed grim obsolescence of equipment and techniques. This combined with their low R&D expenses led to margins that exceeded that of competing digital IC products. This is supported b y Linears 7th seat positioning on the Philadelphia Stock swop Semiconductor Index (SOX).Linears net income was at its senior gamey schoolest in two hundred1, when global technology spending was at its highest, and its lowest sales the avocation year. They still maintained compulsory gold catamenias and strong margins this was accomplished presumee various mechanisms oft(prenominal) as cost cutting aided by their variable cost structure. As of 2003 Q3, Linear was emerging out of the recession with strong financials. However, exculpate line sales and net income remained lower than their high point in 2001. Due to political unrest by means ofout the World, the future of the tech exertion remained unclear. Year over year ripening in 2003 when comp atomic number 18d to 2002 was adept, unless the corpo ration didnt see a clear street to reaching 2001 levels. At the same time, they didnt penury to sacrifice margins in new markets like Asia.By 1992 Linears management was satisfactory in their ability to sustain future notes flows, having been bullion flow positive since IPO, and began issuing dividends of $.00625 per get by (payout ratio 15%). In 2002 LLTC keep issuing dividends, despite the higher payout ratio (27.24%), as they didnt want to lose favor with set upors. It is likely that Linear viewed dividends as a bureau to stay in the portfolio of rough-cut funds and EU investors who strongly successful dividend- remunerative compareentages.Simultaneously, Linear also began to buy keep going piece of grounds when delight rates were low or/and when market valuation of Linear stock was low. They were skeptical active paying out all or more of their hard hard currency in dividends as this could symptom lack of growth potential. It is nonable that many institutional investors held Linear stock, largest among which was Janus Capital. Linear wanted to be sure to convey positive signals to their investors. With a large cash balance ($1.5 one thousand meg) and no debt, Linear was at a crossroads they asked to know what to do with their cash. Their options were 1) Invest in new projects, 2) Payout via dividends and/or redemptions, and 3) Save it for future investments in innovation and diversification. In this p per, we go forth analyze three different approaches in decision makingLinears payout for Q3.Approach 1 Cent Dividend IncreaseThe digest below assumes the decision to repurchase 165.7 zillion in stock depart not be adjusted. The decision to be made is to either come on our dividend by one cent per plow, or leave the third turd dividend of .05 per share intact.Payout DecisionHistorically Linear has not attachd dividends in Q3, so a conservative approach for the board would be to O.K. the continuation of the dividend policy from Q2. Continuing the status quo of .05 per share, the payout ratio would adjust to 27.48 per centum of Net Income. Increasing dividend by one cent per share would a nnex the YTD payout ratio to approximately 29.31 percent for the three accommodate (Exhibit 1), a modest profit.At $0.06 dividend per share, the essence Q3 dividend payout pass on be $18.7 million, which lead still be considered small by our institutional investors, given our large cash position. The word meaning of the 1-cent join on leave alone volunteer a full offering of 215.70 million dollars back to our investors in the form of dividends and stock repurchases as shown below nonrecreational the spare 1-cent would still be consistent with our long-term dividend strategy, but the total package will not be aligned with the requests of well-nigh of our largest investors. operable Cash to DistributeAt this point it is important to note that the theatre will be paying out more to the shareholders via share buybacks and dividends, than the flying has available to the equity holders through its operations. This over honorarium 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 FCFE dollars, but would be choosing to payout a total of 215.7 million given the decision to increase the dividend by one cent. Staying committed to the .05 dividend bowdlerises this figure by only three million.Cash ask and Agency issuesSurplus cash to mete out any unforeseen needs will readily be available by adopting the conservative one-cent increase plan. Increasing the dividend to .06 involves holding on to almost 100 percent of a very large cash position, and therefore provides little pressure to advert such future cash needs.SignalingLinears 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 mark a subject of adeptty and consistency of cash flows to their investors, yet provide options for our turbulent times. Other uses for this cash such as improved employee bonu ss, training, and oeuvre improvements should also be considered.Other ConsiderationsThe drawback for adopting the conservative plan without addressing the concerns of Janus and other similar investors could signal that they are not quite ready to suggest that their new-made 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 Janus and other firms that share their view on Linears current cash position. We address these in Approach 2, 3 outlined in the sections that follow.Approach 2 Payout all of Linear Technologys Cash 1In 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 $5.01 per share, or (b) Repurchasing astir(pre dicate) 50 million shares.(a) Special Dividend of $5.01 per shareOne 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 equal with the take chances normally associated with the purchase of shares from technology companies. Additionally it signals to the market that Linear is unspoiled about sharing its riches with its shareholders. With these higher overall payouts, Linear Technology can reach investors that lease specific income goals.Share priceIn case of a dividend announcement, necessity for shares will rise. If investors know that a real dividend summation 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 $5.01 hence the share price cum dividend can be expected to increase to $35.88.1 Exhibit 4 shows calculations for public figures presented in this sectionFirm valueDepending on th e time until the dividend is paid, not the full amount of dividend is added to the share price. If there is still a certain menses 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 sloppedr 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 project 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 square will not be a decisive factor in the firms value.Payout ratioHowever, in this scenario the payout ratio becomes a ludicrously high 945% (Exhibit-4), which is v ery high compared to peers. (Exhibit 2)SignalingBy deploying capital through an change magnitude dividend versus a share repurchase, management is signaling that Linears 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 come withs growth is fall and there are no new positive NPV projects for the keep company to invest in.However, this may service of process send a positive signal that the company is confident about generating positive cash flows for its operational and investment needs. Since cyberspace 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 problemsIncreasing dividend is also a good way to reduce agency costs. With large amount of cash balance in hand, managers ensure over the capital becomes larger. Paying dividend to the i nvestors is an efficient way to get additional monitoring of the capital, and thus make it less attractive to managers to invest the cash in projects that will reduce the benefits of the shareholders.Tax ClienteleWith 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 drive tax exemptions. Also, the announcement of a dividend may trigger off older and poorer investors to buy more of Linears stock. (b) Share repurchaseShare price and Shares outstandingLinear can repurchase 50.7 (16.23% of viridity shares) million common shares by spending all of its cash. When they do that, the number of outstanding shares will be 261.7 million. Historically, the stock price of companies has risen quest a sharerepurchase announcement as it can progress EPS. In this case EPS increases to $0.65. (Exhibit-4)SignalingBy 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 hypothetical 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 decreaseApproach 3 Payout 50% of Linear Technologys Cash2Considering that management does not have a good line of sight into the future at this point, paying out all of Linears 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 lineing for this quarterly dividend is available f or either a special dividend or a share repurchase.The following section analysis the nitty-gritty of paying out 50% of the remaining cash reserves either in the form of a special dividend of $2.51 or by repurchasing 25.35 million shares.EPS and Share PriceIf we were to repurchase shares using 50% of the cash, the EPS will increase from 0.55 to 0.59 close to the 2002 numbers of 0.62. Using a price/earnings ratio of 56.53 in 2003 (Exhibit-3), we can estimate the share price to increase to 33.65 with this increased EPS, cum dividend.If we were to pay out a special dividend of $2.51 per share instead, the share price cum dividend could be estimated to be a closely comparable $33.38 (Exhibit-5). EPS will be 0.55, very close to Q2 levels (0.54).Payout RatioThe 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 Linears peers (Exhibit-2). In contrast, with a share repurchase, the payout ratio remains a t level consistent with precedent quarters at 27.5%.2 Exhibit 4 shows the calculations for numbers presented in this sectionFirm value and Shareholder wealthRepurchases will help alleviate some of the dilution of the EPS arising out of options awarded to employees and managers, considering that Linears incentives for all employees include stock options. On the other hand, dividends will help distribute the wealth more evenly among all investors, while repurchases cause an uneven dispersion as the shareholders who do not sell will see a drop in book value of the shares, from$5.01 to $3.23 (rough approximation based totally on cash assets Exhibit 5. Tax ClienteleWith the new rules that define equal taxation rate of 15% for Capital gains and OIC, there are no quantifiable advantages one way or the other with notice to the decision to payout either in the form of a special dividend or repurchases. There may however, be some psychological impacts to be considered depending on prefe rences of the shareholders. For example, if the vast majority of shareholders belong to the older demographic, they may prefer it if the stock paid dividends.SignalingLinears investors are apply to acquiring a dividend, and seeing periodic repurchases. Additional payouts of cash help increase ROE and reduce shareholders risk premium. At current low interest rates on cash (as of 2003), paying out at least(prenominal) some of the cash balance appears to be in the best interests of the shareholders. though high payouts may signal that the company is lacking growth potential, it helps send a positive message that the company is keen on sharing its wealth. This message of being a cash-cow is break in compared to the image of a company that is hoarding its wealth.PeersA quick look at Maxims financials indicates that they have started sharing their cash with their shareholders in 2002 their cash returned was over 200% of their FCFE (Exhibit-2), and their cash reserves reduced by 455 mi llion. They appear to have used that cash in repurchases in an effort to concentrate their wealth among a smaller number of shareholders, at the sametime they managed to increase their squeeze line numbers significantly, even compared to 2000. By sharing half their cash with their shareholders, Linear will be able to put itself on par with this close competitor.Agency issues and other considerationsOne time special dividends dont need to be kept up, so are basically similar to repurchases in that respect. However, repurchases help boost EPS and prevent dilution, both of which have longer-lasting personal effects. In this respect a repurchase may be better than a dividend. As far as agency issues go, retaining 50% of the cash position may not provide as much incentive to work harder on identifying positive NPV projects, as expending 100% of the cash, but will work much better than retaining almost all of the cash as in Approach 1.Our Recommendation for LinearOur recommendation to L inear is to maintain status quo with respect to dividends pay the quarterly dividend of $0.05 per share, and to buy back 25.35 million shares using half the cash balance. Dividends consistent with previous quarters of 2003, are recommended to avoid any adverse market reactions, while the company works on figuring out their strategy to increase top line sales and earnings to the 2000-2001 levels or better. Cancelling the dividend altogether or paying less than last quarter is not an option, as this would be perceive very negatively by the market. Historically, Linear has never increased dividends in the Q3 compared to Q2 hence it is safe to maintain a dividend of 5 cents per share as in Q3. Additionally, as shown in Exhibit-2, Linear already pays more dividends compared to peers, including their close competitor Maxim.Paying out all of the cash may denude the company of the required levels of liquidity. Given that the analog semiconductor industry requires ageless innovation and considering opportunities for new ventures such as entering the Asian market, it is safe to assume that the company should keep somecash reserves to account for unknowns.Linear is well aware that they need to expand their business and insure ways to increase top line numbers, so keeping some cash, and supplementing it with capital from debt or/and equity markets is worth looking into. This forms the basis of our cerebrate for recommending the use of only 50% of the cash balance to repurchase shares.Additionally, by repurchasing shares, Linear will be able to still sufficiently signal to the market that the stock is undervalued. At the same time, by maintaining some of the cash balance, they additionally signal the existence of profitable positive NPV projects for Linear to pursue. Considering the industry characteristics, and the stagnation reached in top line revenues, Linear will need to look at innovation and new markets, both of which could bring spectacular increases in growt h. In light of this, we are convinced that the EPS boosting effect of a share repurchase is more valuable to Linear at this point, than the effects of an equitable distribution of shareholder wealth via special dividends.