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• Srikanth Kumar Konduri

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Dividend policy at Linear Technology analysis

Group: G05

Case Submission by: Tarun KSG (10DM-162), Saurabh Thadani (10FN-102), Srikanth Konduri (10FN-109), Tushar Gupta (10FN-115), Nikhil Gupta (10FN-121) 1. Management is debating on the amount of dividend to be paid, corresponding to Q3 FY2003  Purpose: To create a perception (+ve) of its growth prospects among investors  It’s a sign of strong +ve cash flows, profitability of the firm  So firms remain cautious about their pay-out ratio, to sustain their payments in long-run  Ultimately, to maximize the value of shareholders 2. Findings of Academic research: A +ve link between dividend yields & future returns  Probably because: Paying out dividends increases tax burden on the firm  Which encourages management to make better investments with available cash 3. Incentivised to pay dividend only when firm is confident of the future  So that investors will be sure of receiving regular dividend even during downturns  As during downturns interest rates outside fall to low-levels, even 1% dividend yield looks gr8  Propels to increase its market/book ratio relative to non-paying ones  Many Mutual Fund companies & Euro Investment firms prefer stocks with regular dividends 4. Restraint from Executive level employees:  These days technology companies follow a variable cost structure  By making ESOPs as a considerable portion of their compensation & pay as per earnings  So, those guys will try to exercise their options only when the stock price is at higher levels  They will not be interested in the incentive of dividend payment  As that exercise creates dilution, firms will buy-back the shares to offset that effect 5. It will not pay dividends if there are not enough cash-earnings (after off-setting dilution )  Paying dividends without buy-backs will suffer its EPS, though provides cash to investors 6. Restraint generated from its own dividend payment policy during downturns: (along with Iraq war)  For paying dividends, firms need cash reserves  During economic slowdowns, interest rates will be pretty low, rules out short-term investments  In order to maintain cash position even at that time, firms will tend to buy-back shares 7. Restraint to dividend pay-out ratio from its strategic growth pursuit: (Analog-semiconductors)  Looking out for opportunities in Asia while being cautious about bottom-line margin  Investment in R&D($102mn in FY 2001), retaining talent, building fabrication facilities($200mn) 8. In the wake of tax reforms, institutional investors welcome dividend payment  As it reduces the equity risk premium associated with the stock  Corporate scandals like ENRON,WORLDCOM have reinforced this notion 9. If the tax rates are expected to be constant at least for a complete financial year  Institutional investors would rather prefer buy-back than dividend payments(to prevent tax)  Putting it in other way, they expect special dividends if firm’s cash reserves are huge 1|Page

CF-2 Assignment

Dividend policy at Linear Technology analysis

Group: G05

10. Few feel dividend policy as company’s acceptance of the fact investors can gain more elsewhere 11. Let’s see the policy of its benchmark competitors:  Intel, Maxim & Microsoft all have been following regular stock splits  Maxim & Linear have got many similarities, along with institutional investors  Microsoft promised to shift towards dividends after settling its legal claim worth $1.1bn  Linear’s position is 7th in terms of Market Capitalization on Philadelphia SOP index 12. Keeping in mind its objective of maximizing share-holder value:  For long-term relationship maintenance with investors who are bottom-line concerned  Share price of Linear Technology at the end of Q3 FY2003: $30.87  Market Capitalization at the end of Q3 FY2003 is: 312.4*30.87 = $9643.788mn  Net Cash flow during Q1-Q3 of FY2003: $13.2mn; (POR) 2002=54/197.6=27.33%  Total Cash & Short-Term Investments till Q3 FY2003: $1565.2mn  EPS during (Q1-Q3) = 170.6/312.4 = 0.5461 

If the Cash flow is used to buy-back shares:  No. of shares brought back = 13.2mn30.87 = 427,600  New No. of shares=312.4-0.4276 = 311.9724mn  As share price remains intact, new Mkt. Cap. = 311.9724mn*30.87 = $9630.588mn  Post buy-back EPS = 170.6/311.9724 = 0.5468  (∆EPS) post buy-back = 0.00075;(∆Mkt. Cap.) post buy-back = -$13.2mn  As Mkt. Cap. Is reducing with this option, only buy-back policy is ruled out

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If the cash reserves are used to declare special dividend:  Let’s assume special DPS to be $2.5  2.5*312.4mn=$781mn has to be taken out of their cash reserves  Share price will fall by $2.5 and new share price = 30.87-2.5 = $28.37  (∆EPS) post buy-back = 0; (∆Mkt. Cap.) post buy-back = -(311.924mn*2.5)= -$779.81mn  As Mkt. Cap. Is reducing with this option, only special dividend policy is ruled out

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If part of cash reserves are used to buy-back & part to declare special dividend:  Let’s assume that $500mn is used each for dividend payments & buy-backs  For a person holding 100 shares of LLTC, now 5.18 shares will be brought back  (Calculations are present in the attached excel), person’s initial stock value:$3087  Cash obtained from buy-back: 5.18*30.87 = $159.9066  Now, cash earned from dividends declared for remaining 94.82 shares is: $160.06  Ex-dividend date value of the stocks held =94.82*(30.87-1.688)=$2767.04  Person’s new share capital value:159.90+160.06+2767.04= $3087  As the shareholder value is remained same, while holder’s risk premium associated with LLTC is reduced, part buy-back & part dividend payment policy is most welcomed  However, if the Bush’s 2003 tax reforms were delayed, this option may not be attractive than that of share repurchase

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CF-2 Assignment